CEIOPS-DOC-42/09. (former CP 49) October 2009

CEIOPS-DOC-42/09 CEIOPS Advce for Level 2 Imlementng Measures on Solvency II: Standard formula SCR - Artcle 109 c Lfe underwrtng rsk (former CP 49) October 2009 CEIOPS e.v. Westhafenlatz 1-60327 Frankfurt Germany Tel. + 49 69-951119-20 Fax. + 49 69-951119-19 emal: secretarat@ceos.eu; Webste: www.ceos.eu

Table of contents 1. Introducton... 3 2. Extract from Level 1 text... 4 3. Advce... 6 3.1 General consderatons 6 3.1.1. Exlanatory text... 6 3.1.2. CEIOPS advce... 7 3.2 Mortalty rsk 7 3.2.1. Exlanatory text... 7 3.2.2. CEIOPS advce... 9 3.3. Longevty rsk 10 3.3.1. Exlanatory text... 10 3.3.2. CEIOPS advce... 12 3.4. Dsablty-morbdty rsk 13 3.4.1. Exlanatory text... 13 3.4.2. CEIOPS advce... 15 3.5 Lfe exense rsk 16 3.5.1. Exlanatory text... 16 3.5.2. CEIOPS advce... 17 3.6 Revson rsk 18 3.6.1. Exlanatory text... 18 3.6.2. CEIOPS advce... 19 3.7 Lase rsk 19 3.7.1 Exlanatory text... 19 3.7.2 CEIOPS advce... 29 3.8 Lfe catastrohe rsk 33 3.8.1. Exlanatory text... 33 3.8.2. CEIOPS advce... 35 Annex A Estmate of the volatlty n dsablty ncdence and recovery (Swedsh FSA).... 36 Annex B Longevty rsk calbraton analyss... 39 Annex C Analyss of annual lase rates n the Polsh lfe nsurance market... 42 Annex D Imact assessment on lfe underwrtng rsk... 46 2/49

1. Introducton 1.1. In ts letter of 19 July 2007, the Euroean Commsson requested CEIOPS to rovde fnal, fully consulted advce on Level 2 mlementng measures by October 2009 and recommended CEIOPS to develo Level 3 gudance on certan areas to foster suervsory convergence. On 12 June 2009 the Euroean Commsson sent a letter wth further gudance regardng the Solvency II roject, ncludng the lst of mlementng measures and tmetable untl mlementaton. 1 1.2. Ths Paer ams at rovdng advce wth regard to the desgn, structure and calbraton of the lfe underwrtng module for the standard formula for the Solvency Catal Requrement as requested n Artcle 111 of the Solvency II Level 1 text. 2 1.3. Correlatons between the lfe underwrtng rsk sub-modules and between the lfe underwrtng module and other modules are not covered by ths draft advce. They have been addressed n the thrd set of advce released for consultaton n November 2009. 1.4. Ths Paer only covers smlfcatons to the standard formula wth regard to the lase rsk sub-module. CEIOPS has ublshed a further consultaton aer coverng smlfcatons n the thrd set of advce n November 2009. 1 See htt://www.ceos.eu/content/vew/5/5/ 2 Latest verson from 19 October 2009 avalable at htt://regster.conslum.euroa.eu/df/en/09/st03/st03643-re01.en09.df. 3/49

2. Extract from Level 1 text Legal bass for mlementng measure Artcle 111 - Imlementng measures 1. In order to ensure that the same treatment s aled to all (re)nsurance and rensurance undertakngs calculatng the Solvency Catal Requrement on the bass of the standard formula, or to take account of market develoments, the Commsson shall adot mlementng measures layng down the followng: [ ] (a) a standard formula n accordance wth the rovsons of Artcles 101 and 103 to 109; (b) (c) (d) (k) any sub-modules necessary or coverng more recsely the rsks whch fall under the resectve rsk modules referred to n Artcle 104 as well as any subsequent udates; the methods, assumtons and standard arameters to be used, when calculatng each of the rsk modules or sub-modules of the Basc Solvency Catal Requrement lad down n Artcles 104, 105 and 304; where nsurance and rensurance undertakngs use rsk mtgaton technques, the methods and assumtons to be used to assess the changes n the rsk rofle of the undertakng concerned and adjust the calculaton of the Solvency Catal Requrement; the smlfed calculatons rovded for secfc sub-modules and rsk modules, as well as the crtera that nsurance and rensurance undertakngs shall be requred to meet n order to be enttled to use each of these smlfcatons, as set out n Artcle 109; Other relevant artcles for rovsdng background to the advce Artcle 105 - Calculaton of the Basc Solvency Catal Requrement [...] 3. The lfe underwrtng rsk module shall reflect the rsk arsng from the lfe nsurance oblgatons, n relaton to the erls covered and the rocesses used n the conduct of busness. It shall be calculated, n accordance wth ont 2 of Aendx IV, as a combnaton of the catal requrements for at least the followng submodules: 4/49

(a) (b) (c) (d) (e) (f) (g) the rsk of loss, or of adverse change n the value of nsurance labltes, resultng from changes n the level, trend, or volatlty of mortalty rates, where an ncrease n the mortalty rate leads to an ncrease n the value of nsurance labltes (mortalty rsk); the rsk of loss, or of adverse change n the value of nsurance labltes, resultng from changes n the level, trend, or volatlty of mortalty rates, where a decrease n the mortalty rate leads to an ncrease n the value of nsurance labltes (longevty rsk); the rsk of loss, or of adverse change n the value of nsurance labltes, resultng from changes n the level, trend or volatlty of dsablty, sckness and morbdty rates (dsablty morbdty rsk); the rsk of loss, or of adverse change n the value of nsurance labltes, resultng from changes n the level, trend, or volatlty of the exenses ncurred n servcng nsurance or rensurance contracts (lfe exense rsk); the rsk of loss, or of adverse change n the value of nsurance labltes resultng from fluctuatons n the level, trend, or volatlty of the revson rates aled to annutes, due to changes n the legal envronment or n the state of health of the erson nsured (revson rsk); the rsk of loss, or of adverse change n the value of nsurance labltes, resultng from changes n the level or volatlty of the rates of olcy lases, termnatons, renewals and surrenders (lase rsk); the rsk of loss, or of adverse change n the value of nsurance labltes, resultng from the sgnfcant uncertanty of rcng and rovsonng assumtons related to extreme or rregular events (lfe catastrohe rsk). Artcle 109 - Smlfcatons n the standard formula Insurance and rensurance undertakngs may use a smlfed calculaton for a secfc sub-module or rsk module where the nature, scale and comlexty of the rsks they face justfes t and where t would be dsroortonate to requre all nsurance and rensurance undertakngs to aly the standardsed calculaton. Smlfed calculatons shall be calbrated n accordance wth Artcle 101(3). 5/49

3. Advce 3.1 General consderatons 3.1.1. Exlanatory text Desgn and structure 3.1. A number of the lfe underwrtng rsk stresses are based on a delta-nav (change n value of assets mnus labltes) aroach. The change n net asset value should be based on a balance sheet that does not nclude the rsk margn of the techncal rovsons. Ths aroach s based on the assumton that the rsk margn does not change materally under the scenaro stress. Ths smlfcaton s made to avod a crcular defnton of the SCR snce the sze of the rsk margn deends on the SCR. 3.2. Furthermore, where a delta-nav aroach s used, the revaluaton of techncal rovsons should allow for any relevant adverse changes n oton take-u behavour of olcyholders n ths scenaro. 3.3. Underwrtng rsks can affect an undertakng s labltes as well as ts assets. The scoe of the lfe underwrtng module s not confned to the labltes. Calbraton 3.4. The calbraton of the lfe underwrtng arameters should cature changes n the level, trend and volatlty of the arameter. However, for QIS3, t was decded to reduce the comlexty of the desgn of the underwrtng rsk module by mantanng the level and trend rsk comonents only. It s assumed that the volatlty rsk comonent s mlctly covered by the level, trend and catastrohe rsk comonents. Ths s consdered to be accetable snce, for QIS2, the volatlty rsk roved to be consderably lower than the trend rsk. CEIOPS therefore rooses to retan ths aroach. 3.5. CEIOPS onts out that the calbraton n ths advce s beng consdered to be n lne wth 99.5% VaR and a one year tme horzon, ncororatng the exerence from the current crss. QIS5 wll gve an ndcaton of the overall mact of the roosed calbratons, not lmted to the SCR but ncludng techncal rovsons and own funds. 6/49

3.1.2. CEIOPS advce General consderatons 3.4. The change n net asset value shall be based on a balance sheet that does not nclude the rsk margn of the techncal rovsons. 3.5. The revaluaton should allow for any relevant adverse changes n oton take-u behavour of olcyholders n ths scenaro. 3.6. Where rsk mtgaton technques meet the requrements set out n CEIOPS Advce on rensurance and fnancal rsk mtgaton, the scenaros requred for the calculaton of the lfe underwrtng rsk module wll ncororate ther effect. 3.7. The calbraton of the lfe underwrtng arameters shall cature changes n the level and trend of the arameters only. It s assumed that the volatlty rsk comonent s mlctly covered by the level, trend and catastrohe rsk comonents. 3.2 Mortalty rsk 3.2.1. Exlanatory text Introducton 3.8. Mortalty rsk s assocated wth (re)nsurance oblgatons (such as term assurance or endowment olces) where a (re)nsurance undertakng guarantees to make a sngle or recurrng seres of ayments n the event of the death of the olcyholder durng the olcy term. 3.9. It s alcable for (re)nsurance oblgatons contngent on mortalty rsk.e. where the amount currently ayable on death exceeds the techncal rovsons held and, as a result, an ncrease n mortalty rates s lkely to lead to an ncrease n the techncal rovsons. 3.10. The catal charge for mortalty rsk s ntended to reflect the uncertanty n mortalty arameters as a result of changes n the level, trend and volatlty of mortalty rates and cature the rsk that more olcyholders than antcated de durng the olcy term. 3.11. Ths rsk s normally catured by ncreasng the mortalty rates ether by a fxed amount or by a roorton of the base mortalty rates. The calbraton (of the ncrease) should cature the mact of each of the above factors (level, trend and volatlty). Mortalty rsk n QIS4 3.12. The QIS4 aroach to the SCR standard formula ncluded a mortalty rsk sub-module n the lfe underwrtng rsk module (secton TS.XI.B of the QIS4 Techncal Secfcatons (MARKT/2505/08)). The calculaton of the catal requrement for mortalty rsk was a scenaro based stress. The scenaro tested was a ermanent 10% ncrease n mortalty rates. 7/49

3.13. QIS4 feedback from several Member States suggested that a gradual change to nceton rates and trends would be more arorate than a one-off shock for bometrc rsks. 3.14. QIS4 feedback on the calbraton of the mortalty stress was vared. Some undertakng felt that the calbraton was too strong and wthout suffcent granularty whereas other undertakngs thought that the calbraton was below the 99.5th ercentle. 3.15. QIS4 also tested alternatve aroaches for dealng wth (re)nsurance oblgatons whch rovde benefts on both death and survval. The frst oton roosed that where the death and survval benefts are contngent on the lfe of the same nsured erson(s), the oblgaton should not be unbundled. Under the second oton, all contracts were unbundled nto two searate comonents: one contngent on the death and other contngent on the survval of the nsured erson(s). Only the former comonent was taken nto account for the alcaton of the mortalty scenaro. 3.16. Feedback from QIS4 ndcated that the vast majorty of (re)nsurance undertakngs chose not to unbundle the oblgatons (oton one). The ractcal dffculty n unbundlng oblgatons was cted as the man reason for choosng ths oton. Undertakngs n one Member State also noted that ths (oton one) was consstent wth IFRS classfcatons. Where suervsors offered vews, they generally agreed wth undertakngs. However one Member State argued that more analyss would be necessary before decdng on the most arorate oton. Calculaton of the catal requrement 3.17. QIS4 artcants suggested that a gradual change to nceton rates and trends would be more arorate than a one-off shock for bometrc rsks. However CEIOPS has consdered ths roosal (see n artcular dscusson under longevty rsk below) and has concluded that a one-off shock s more arorate n the context of the standard formula. 3.18. The catal requrement should therefore be calculated as the change n net asset value (assets mnus labltes) followng a ermanent ncrease n mortalty rates of x%. Calbraton of mortalty stress 3.19. The bass for the QIS4 calbraton of the mortalty rsk stress s descrbed n the CEIOPS aer QIS3 Calbraton of underwrtng rsk, market rsk and MCR. Ths aer s avalable from the CEIOPS webste 3. 3.20. As mentoned above, QIS4 feedback on the calbraton of the mortalty stress was vared. However an analyss of the mortalty stress arameters rovded by frms usng nternal models ndcated that the standard formula arameter was relatvely low. Based on a samle sze of 21 nternal model, the medan stress was 22%, wth an nter quartle range of 13% to 29%. Ths s sgnfcantly hgher than the standard formula calbraton of 10%. 3 htt://www.ceos.eu/meda/fles/consultatons/qis/qis3/qis3calbratonpaers.df 8/49

3.21. CEIOPS therefore rooses to amend the calbraton of the mortalty stress to a ermanent ncrease n mortalty rates of 15%. Unbundlng of (re)nsurance oblgatons 3.22. Where (re)nsurance oblgatons rovde benefts both n case of death and survval and the death and survval benefts are contngent on the lfe of the same nsured erson(s), these oblgatons should not be unbundled. For these contracts the mortalty scenaro should be aled fully allowng for the nettng effect rovded by the natural hedge between the death benefts comonent and the survval benefts comonent (note that a floor of zero ales at the level of contract f the net result of the scenaro s favourable to the (re)nsurer). 3.23. Where oblgatons can be unbundled but are not materal, then unbundlng should not be requred, n lne wth CEIOPS advce on segmentaton (see CEIOPS-DOC-22/09) 4. 3.24. Where model onts are used for the uroses of calculatng the techncal rovsons and the groung of the data catures arorately the mortalty rsk of the ortfolo, each model onts can be consdered to reresent a sngle nsured erson for the uroses of alyng the above advce. 3.2.2. CEIOPS advce Mortalty rsk 3.23. Based on the assumtons contaned n the exlanatory text, CEIOPS has calbrated the sub-module accordng to 99.5% VaR and a one year tme horzon. 3.24. The mortalty rsk sub-module s alcable for (re)nsurance oblgatons contngent on mortalty rsk.e. where the amount currently ayable on death exceeds the techncal rovsons held and, as a result, an ncrease n mortalty rates leads to an ncrease n the techncal rovsons. 3.25. The calculaton of the catal requrement for mortalty rsk shall be a scenaro based stress. 3.26. The catal requrement shall be calculated as the change n net asset value (assets mnus labltes) followng a ermanent ncrease n mortalty rates of 15%. 3.27. Where (re)nsurance oblgatons rovde benefts both n case of death and survval and the death and survval benefts are contngent on the lfe of the same nsured erson(s), these oblgatons should not be unbundled. For these contracts the mortalty scenaro should be aled fully allowng for the nettng effect rovded by the natural hedge between the death benefts comonent and the survval benefts comonent (note that a floor of zero ales at the level of contract f the net result of the scenaro s favourable to the (re)nsurer). 4 Former CP 27. See htt://www.ceos.eu/ndex.h?oton=content&task=vew&d=575. 9/49

3.28. Where model onts are used for the uroses of calculatng the techncal rovsons and the groung of the data catures arorately the mortalty rsk of the ortfolo, each model onts can be consdered to reresent a sngle nsured erson for the uroses of alyng the above advce. 3.3. Longevty rsk 3.3.1. Exlanatory text Introducton 3.29. Longevty rsk s assocated wth (re)nsurance oblgatons (such as annutes) where a (re)nsurance undertakng guarantees to make recurrng seres of ayments untl the death of the olcyholder and where a decrease n mortalty rates leads to an ncrease n the techncal rovsons, or wth (re)nsurance oblgatons (such as ure endowments) where a (re)nsurance undertakng guarantees to make a sngle ayment n the event of the survval of the olcyholder for the duraton of the olcy term. 3.30. It s alcable for (re)nsurance oblgatons contngent on longevty rsk.e. where there s no death beneft or the amount currently ayable on death s less than the techncal rovsons held and, as a result, a decrease n mortalty rates s lkely to lead to an ncrease n the techncal rovsons. 3.31. The rsk that a olcyholder lves longer than antcated s longevty rsk. Longevty rsk s artcularly sgnfcant as a result of an ncreasng lfe exectancy among olcyholders n most develoed countres. 3.32. The catal charge for longevty rsk s ntended to reflect the uncertanty n mortalty arameters as a result of changes n the level, trend and volatlty of mortalty rates and cature the rsk of olcyholders lvng longer than antcated. 3.33. Ths rsk may be catured n a number of dfferent ways: a smle aroach of a reducton n base mortalty rates, a more realstc aroach of usng mrovement factors whch leads to a two dmensonal mortalty table, or a combnaton of these two aroaches. In any event, the calbraton (of the ncrease) should cature the mact of each of the above factors (level, trend and volatlty). Longevty rsk n QIS4 3.34. The QIS4 aroach to the SCR standard formula ncluded a longevty rsk sub-module n the lfe underwrtng rsk module (secton TS.XI.C of the QIS4 Techncal Secfcatons (MARKT/2505/08)). The calculaton of the catal requrement for longevty rsk was a scenaro based stress. The scenaro tested was a ermanent 25% decrease n mortalty rates. 3.35. QIS4 feedback from several Member States suggested that a gradual change to nceton rates and trends would be more arorate than a one-off shock for bometrc rsks. 3.36. Wth regard to the calbraton of the longevty stress, several undertakngs argued for an age and duraton deendent treatment of longevty, 10/49

renforcng more general comments that a one-off shock s not the most arorate form of stress for bometrc rsks. An mrovement of x% er annum (over base mortalty) was suggested as an alternatve by one resondent. 3.37. Some undertakngs felt the longevty shock was too conservatve. Calculaton of the catal requrement 3.38. QIS4 artcants suggested that a gradual change to nceton rates and trends would be more arorate than a one-off shock for bometrc rsks. For examle, one resondent suggested that an mrovement of x% er annum (over base mortalty) could be used as an alternatve. 3.39. Subsequent to QIS4, an analyss by UNESPA roosed an alternatve structure to the longevty shock whch deended on age and duraton. 3.40. CEIOPS has consdered the above mentoned roosals but has concluded that a one-off shock to longevty s more arorate for the uroses of the standard formula for the followng reasons: It s more straghtforward to aly Wth resect to dfferentatng by duraton, CEIOPS nvestgatons (see Aendx B to ths aer) ndcate that shocks for dfferent duratons are small and are not monotone. Wth resect to dfferentatng by age, ortfolos of (re)nsurance oblgatons for whch longevty rsk s alcable are generally heavly weghted n favour of older age grous. We do not beleve that there s suffcent relable data to calbrate at a more granular level 3.41. The catal requrement should therefore be calculated as the change n net asset value (assets mnus labltes) followng a ermanent decrease n mortalty rates of x%. Calbraton of longevty stress 3.42. The bass for the QIS4 calbraton of the longevty rsk stress s descrbed n the CEIOPS aer QIS3 Calbraton of underwrtng rsk, market rsk and MCR. 5 3.43. Subsequent to QIS4, an nvestgaton has been carred out by the Polsh FSA whch analysed the mortalty data for nne countres ndcated based both on hstorc mrovements and a stochastc model of future mortalty mrovements. 3.44. The results of ths analyss ndcated that, on average (across the nne countres for whch data was analysed), hstorc mrovements n mortalty rates over 15 years from 1992 to 2006 were hgher than 25%. Although the results of the stochastc model of future mortalty mrovements may mly a lower stress, CEIOPS has attached more weght to the analyss of hstorc mrovements because of the sgnfcant uncertanty nherent n modellng mortalty. 5 htt://www.ceos.eu/meda/fles/consultatons/qis/qis3/qis3calbratonpaers.df. 11/49

3.45. Furthermore feedback from nternal model frms as art of QIS4 ndcates that the medan stress was 25%. 3.46. CEIOPS therefore rooses to mantan the QIS4 calbraton of the longevty rsk stress.e. the stress shall be based on a ermanent 25% decrease n the mortalty rates assumed n the calculaton of best estmate. Unbundlng of (re)nsurance oblgatons 3.47. Where (re)nsurance oblgatons rovde benefts both n case of death and survval and the death and survval benefts are contngent on the lfe of the same nsured erson(s), these oblgatons should not be unbundled. For these contracts the longevty scenaro should be aled fully allowng for the nettng effect rovded by the natural hedge between the death benefts comonent and the survval benefts comonent (note that a floor of zero ales at the level of contract f the net result of the scenaro s favourable to the (re)nsurer). 3.48. Where model onts are used for the uroses of calculatng the techncal rovsons and the groung of the data catures arorately the longevty rsk of the ortfolo, each model onts can be consdered to reresent a sngle nsured erson for the uroses of alyng the above advce. 3.3.2. CEIOPS advce Longevty rsk 3.49. Based on the assumtons contaned n the exlanatory text, CEIOPS has calbrated the sub-module accordng to 99.5% VaR and a one year tme horzon. 3.50. The longevty rsk sub-module s alcable for (re)nsurance oblgatons contngent on longevty rsk.e..e. where there s no death beneft or the amount currently ayable on death s less than the techncal rovsons held and, as a result, a decrease n mortalty rates s lkely to lead to an ncrease n the techncal rovsons. 3.51. The calculaton of the catal requrement for longevty rsk shall be a scenaro based stress. 3.52. The catal requrement shall be calculated as the change n net asset value (assets mnus labltes) followng a ermanent decrease n mortalty rates of 25%. 3.53. Where (re)nsurance oblgatons rovde benefts both n case of death and survval and the death and survval benefts are contngent on the lfe of the same nsured erson(s), these oblgatons should not be unbundled. For these contracts the longevty scenaro should be aled fully allowng for the nettng effect rovded by the natural hedge between the death benefts comonent and the survval benefts comonent (note that a floor of zero ales at the level of contract f the net result of the scenaro s favourable to the (re)nsurer). 12/49

3.54. Where model onts are used for the uroses of calculatng the techncal rovsons and the groung of the data catures arorately the longevty rsk of the ortfolo, each model onts can be consdered to reresent a sngle nsured erson for the uroses of alyng the above advce. 3.4. Dsablty-morbdty rsk 3.4.1. Exlanatory text Introducton 3.55. Morbdty or dsablty rsk s assocated wth all tyes of nsurance comensatng or rembursng losses (e.g. loss of ncome) caused by llness, accdent or dsablty (ncome nsurance), or medcal exenses due to llness, accdent or dsablty (medcal nsurance), or where morbdty acts as an acceleraton of ayments or oblgatons whch fall due on death. 3.56. It s alcable for (re)nsurance oblgatons contngent on a defnton of dsablty. However CEIOPS exects that the majorty of (re)nsurance oblgatons for whch dsablty-morbdty rsk s alcable wll be covered by the health module rather than by the lfe underwrtng module. Ths sub-module of the lfe underwrtng rsk module s therefore lkely to be alcable only n cases where t s not arorate to unbundle contracts. 3.57. Where oblgatons can be unbundled but are not materal, then unbundlng should not be requred, n lne wth the rncle of materalty develoed n the CEIOPS advce on segmentaton (see CEIOPS-DOC-22/09 mentoned revously. 3.58. The catal charge for morbdty or dsablty rsk s ntended to reflect the uncertanty n morbdty and dsablty arameters as a result of changes n the level, trend and volatlty of dsablty, sckness and morbdty rates and cature the rsk that more olcyholders than antcated are dagnosed wth the dseases covered or are or unable to work as a result of sckness or dsablty durng the olcy term. 3.59. The (re)nsurance oblgatons may be structured such that, uon the dagnoss of a dsease or the olcyholder beng unable to work as a result of sckness or dsablty, recurrng ayments are trggered. These ayments may contnue untl the exry of some defned erod of tme or untl ether the recovery or death of the olcyholder. In the latter case, the (re)nsurance undertakng s also exosed to the rsk that the olcyholders receves the ayments for longer than antcated.e. that clam termnaton rates are lower than antcated (recovery rsk). 3.60. Morbdty and dsablty rsk s normally catured by ncreasng the clam nceton rate ether by a fxed amount or by a roorton of the base nceton rates and, where alcable, reducng the clam termnaton rates. The calbraton (of the ncrease) should cature the mact of each of the above factors (level, trend and volatlty). 13/49

Morbdty and dsablty rsk n QIS4 3.61. The QIS4 aroach to the SCR standard formula ncluded a morbdty and dsablty rsk sub-module n the lfe underwrtng rsk module (secton TS.XI.B of the QIS4 Techncal Secfcatons (MARKT/2505/08)). The calculaton of the catal requrement for morbdty and dsablty rsk was a scenaro based stress. The scenaro tested was an ncrease of 35% to dsablty rates for the frst year followed by a 25% ncrease n dsablty rates for all subsequent years. 3.62. An alternatve scenaro was also roosed by the UK under whch the catal charges for crtcal llness, ncome rotecton and long term care oblgatons were calculated searately and there was an addtonal catal charge n resect of recovery rsk. 3.63. There were a number of comments from QIS4 artcants on the general methodology of the morbdty and dsablty stress: One resondent argued that recovery rates should be taken nto account. There was some confuson over the treatment of dsablty n terms of catastrohe rsk. Suort for the UK alternatve aroach was noted by one Member State. 3.64. Wth resect to the calbraton of the morbdty and dsablty stress, some (re)nsurance undertakngs commented that the calbraton was too strong. Calculaton of the catal requrement 3.65. As descrbed above, there are two asects to morbdty/dsablty rsk: The rsk that the number of clams are greater than antcated The rsk that the duraton of the clam s hgher than antcated The second rsk s only alcable for (re)nsurance oblgatons where benefts consst of recurrng ayments whch contnue untl ether the recovery or death of the olcyholder. 3.66. Therefore the catal requrement should be calculated as: The change n net asset value (assets mnus labltes) followng an ncrease of x 1 % n morbdty/dsablty nceton rates for the frst year followed by an ncrease of x 2 % n morbdty/dsablty nceton rates for all subsequent years. Plus, where alcable, the change n net asset value (assets mnus labltes) followng a ermanent decrease of y% n morbdty/dsablty recovery rates Calbraton of morbdty and dsablty stress 3.67. The bass for the QIS4 calbraton of the morbdty-dsablty rsk stress s descrbed n the CEIOPS aer QIS3 Calbraton of underwrtng rsk, market rsk and MCR. Ths aer s avalable from the CEIOPS webste. 14/49

3.68. Subsequent to QIS4, an nvestgaton by the Swedsh FSA ndcated that an ncrease of 50% n morbdty/dsablty nceton rates for the frst year would be more arorate. 3.69. Ths nvestgaton also suggested that the arorate calbraton of the decrease n morbdty/dsablty recovery rates was 20%. 3.70. The results of the nvestgaton by the Swedsh FSA are exlaned further n Aendx A. 3.71. In addton, the UK Actuaral Professon Healthcare Reservng Workng Party has undertaken a survey whch nvestgated the levels of 1 n 200 year morbdty stresses used by the major UK lfe nsurance frms. 6 3.72. The range of stress used by the major UK lfe nsurers for ncome rotecton busness averaged 27% for nceton rates and 15% for termnaton rates. For crtcal llness, morbdty margns, ntended to reresent a 99.5% confdence over 1 year, averaged around 40%. 3.73. Furthermore, on average, the average morbdty margns for statutory reservng for crtcal llness and ncome rotecton (both ncetons and termnatons) were about 20%. The margns n a statutory reservng bass are artly to allow for adverse devatons of the nceton and termnaton rates used n the rcng. As such, a 1 n 200 stress should be at least greater than these margns as these margns are not normally set at the same level as a 1 n 200 year scenaro. 3.74. Lookng at the results of ths survey n conjuncton wth the results of the nvestgaton by the Swedsh FSA, we would roose the followng calbraton of the dsablty-morbdty stress: The change n net asset value (assets mnus labltes) followng an ncrease of 50% n morbdty/dsablty nceton rates for the frst year followed by an ncrease of 25% n morbdty/dsablty nceton rates for all subsequent years. Plus, where alcable, the change n net asset value (assets mnus labltes) followng a ermanent decrease of 20% n morbdty/dsablty recovery rates. Ths should be aled together wth the above ncrease n nceton rates.e. t s a combned stress. 3.4.2. CEIOPS advce Morbdty-dsablty rsk 3.75. Based on the assumtons contaned n the exlanatory text, CEIOPS has calbrated the sub-module accordng to 99.5% VaR and a one year tme horzon. 3.76. The morbdty-dsablty rsk sub-module s alcable for (re)nsurance oblgatons contngent on a defnton of dsablty. 3.77. The calculaton of the catal requrement for dsablty rsk shall be a scenaro based stress. 6 htt://www.actuares.org.uk/ data/assets/df_fle/0006/136707/reservng_survey.df. 15/49

3.78. The catal requrement shall be calculated as the change n net asset value (assets mnus labltes) followng: An ncrease of 50% n morbdty/dsablty nceton rates for the frst year followed by an ncrease of 25% n morbdty/dsablty nceton rates for all subsequent years. Plus, where alcable, a ermanent decrease of 20% n morbdty/dsablty recovery rates. 3.5 Lfe exense rsk 3.5.1. Exlanatory text Introducton 3.79. Exense rsk arses from the varaton n the exenses ncurred n servcng nsurance or rensurance contracts. 3.80. It s lkely to be alcable for all (re)nsurance oblgatons. 3.81. The catal charge for exense rsk s ntended to reflect the uncertanty n exense arameters as a result of changes n the level, trend or volatlty the exenses ncurred. 3.82. Ths rsk s normally catured by ncreasng exected future exenses by a fxed roorton, ncreasng exected future exense nflaton or a combnaton of both. Exense rsk n QIS4 3.83. The QIS4 aroach to the SCR standard formula ncluded an exense rsk sub-module n the lfe underwrtng rsk module (secton TS.XI.F of the QIS4 Techncal Secfcatons (MARKT/2505/08)). The calculaton of the catal requrement for exense rsk was a scenaro based stress. The scenaro tested was: An ncrease of 10% n future exenses comared to best estmate antcatons, An ncrease of 1% er annum of the exense nflaton rate comared to antcatons For olces wth adjustable loadngs 7, 75% of these addtonal exenses can be recovered from year 2 onwards by ncreasng the charges ayable by olcyholders. 3.84. There was a range of onons wth regard to the calbraton of the exense rsk as a result of whch no useful concluson could be drawn. Calculaton of the catal requrement 3.85. QIS4 artcants dd not rase any sgnfcant ssues wth the desgn and structure of ths module and CEIOPS has therefore concluded that the aroach adoted n QIS4 s arorate. 7 Polces wth adjustable loadngs are those for whch exense loadngs or charges may be adjusted wthn the next 12 months. 16/49

3.86. The catal requrement should therefore be calculated as the change n net asset value (assets mnus labltes) followng: An ncrease of x% n future exenses comared to best estmate antcatons, An ncrease of y% er annum of the exense nflaton rate comared to antcatons 3.87. However CEIOPS does not ntend to retan the secfc reference to olces wth adjustable loadngs. Ths s because any future change to charges ayable by olcyholders s, n essence, a management acton and should thus be consdered n lght of CEIOPS advce on management actons rather than secfed by CEIOPS. 3.88. CEIOPS notes that some frms have outsourced ther exense actvtes (for examle IT systems, olcyholder comlants handlng etc.), ths can roduce a dfferent set of rsks whch, f sgnfcant, may mean the catal charge n resect of exense rsk outsde of the standard formula calbraton. Calbraton of exense stress 3.89. The bass for the QIS4 calbraton of the exense rsk stress s descrbed n the CEIOPS aer QIS3 Calbraton of underwrtng rsk, market rsk and MCR. Ths aer s avalable from the CEIOPS webste. 3.90. As mentoned above, QIS4 feedback on the calbraton of the exense stress was vared. However the exense rsk catal charge from the nternal model tended to be, for many undertakngs, n lne wth the standard formula. The medan rato was equal to 100% and the nter quartle range was 85% to 166%. 3.91. CEIOPS therefore rooses to mantan the QIS4 calbraton of the exense rsk stress.e. the stress shall be based on: An ncrease of 10% n future exenses comared to best estmate antcatons, An ncrease of 1% er annum of the exense nflaton rate comared to antcatons 3.5.2. CEIOPS advce Exense rsk 3.92. Based on the assumtons contaned n the exlanatory text, CEIOPS has calbrated the sub-module accordng to 99.5% VaR and a one year tme horzon. 3.93. The calculaton of the catal requrement for exense rsk shall be a scenaro based stress. 3.94. The catal requrement shall be calculated as the change n net asset value (assets mnus labltes) followng: An ncrease of 10% n future exenses comared to best estmate antcatons, 17/49

An ncrease of 1% er annum of the exense nflaton rate comared to antcatons 3.6 Revson rsk 3.6.1. Exlanatory text Introducton 3.95. In the context of the lfe underwrtng rsk module, revson rsk s ntended to cature the rsk of adverse varaton of an annuty s amount, as a result of an unantcated revson of the clams rocess. 3.96. Ths rsk should be aled only to: Annutes arsng from non-lfe clams (ncludng accdent nsurance, but excludng workers comensaton) where the amount of the annuty may be revsed durng the next year. Benefts that can be aroxmated by a lfe annuty arsng from non-lfe clams (ncludng accdent nsurance, but excludng workers comensaton) where the amount of the annuty may be revsed durng the next year. Revson rsk n QIS4 3.97. The QIS4 aroach to the SCR standard formula ncluded a revson rsk sub-module n the lfe underwrtng rsk module (secton TS.XI.G of the QIS4 Techncal Secfcatons (MARKT/2505/08)). The calculaton of the catal requrement for revson rsk was a scenaro based stress. The scenaro tested was an ncrease of 3% n the annual amount ayable for annutes exosed to revson rsk. 3.98. QIS4 feedback ndcated that the alcaton of the revson rsk module was not unversally clear n some member states. Ths has been addressed by exandng on the alcaton of ths sub-module n the ntroducton above. 3.99. Wth regard to the calbraton of the revson rsk stress, one undertakng stated that the shock for revson rsk s too low. Calculaton of the catal requrement 3.100. QIS4 artcants dd not rase any ssues wth the desgn and structure of ths module and CEIOPS has therefore concluded that the aroach adoted n QIS4 s arorate. 3.101. The catal requrement should therefore be calculated as the change n net asset value (assets mnus labltes) followng an ncrease of x% n the annual amount ayable for annutes exosed to revson rsk. Calbraton of revson rsk stress 3.102. The bass for the QIS4 calbraton of the revson rsk stress s descrbed n the CEIOPS aer QIS3 Calbraton of underwrtng rsk, market rsk and MCR. Ths aer s avalable on the CEIOPS webste. 3.103. Only one artcant n QIS4 commented on the calbraton of ths module. CEIOPS has therefore concluded that the calbraton adoted n QIS4 s arorate for the majorty of (re)nsurance undertakngs. 18/49

3.104. CEIOPS therefore rooses that the revson rsk s calculated assumng an ncrease of 3% n the annual amount ayable for annutes exosed to revson rsk. 3.6.2. CEIOPS advce Revson rsk 3.105. Based on the assumtons contaned n the exlanatory text, CEIOPS has calbrated the sub-module accordng to 99.5% VaR and a one year tme horzon. 3.106. The calculaton of the catal requrement for revson rsk shall be a scenaro based stress. 3.107. The catal requrement shall be calculated as the change n net asset value (assets mnus labltes) followng an ncrease of 3% n the annual amount ayable for annutes exosed to revson rsk. 3.7 Lase rsk 3.7.1 Exlanatory text Prevous advce 3.108. In ts Further advce to the Euroean Commsson on Pllar 1 ssues of March 2007, CEIOPS recommended the ncluson of an exlct requrement for lase rsk under the SCR standard formula. Lase rsk was understood to arse from unantcated (hgher or lower) rate of olcy lases, termnatons, changes to ad-u status (cessaton of remum ayment) and surrenders. 8 3.109. In the advce document t was noted that the comlex deendence structure of lase rsk s dffcult to model n a modular aroach to the standard formula. 9 Lase rsk n QIS4 3.110. The QIS4 aroach to the SCR standard formula ncluded a lase rsk submodule n the lfe underwrtng rsk module. 10 The calculaton of the catal requrement for lase rsk was based on three scenaros: a ermanent ncrease of lase rates by 50%; a ermanent decrease of lase rates by 50%; and a mass lase event where 30% of the olces are surrendered. 8 See htt://www.ceos.eu/meda/fles/ublcatons/submssonstotheec/ceiops-doc-08-07advceonpllari- Issues-FurtherAdvce.df, CEIOPS-DOC-08/07, March 2007 (hereafter Advce of March 2007 ). 9 Advce of March 2007, aragrah 5.24. 10 QIS4 techncal secfcatons, see htt://www.ceos.eu/meda/docman/techncal%20secfcatons%20qis4.doc, 31 March 2008, Secton TS.XI.E. 19/49

Treatment of lase rsk n the scenaro calculatons 3.111. For lfe nsurance, the calculaton of the SCR s essentally scenaro-based: all lfe nsurance underwrtng rsks and all market rsks excet sread rsk and concentraton rsk are quantfed by means of scenaro analyss. Moreover, the loss-absorbng caacty of techncal rovsons s determned by means of a scenaro. 3.112. The defnton of these scenaros s usually understood as follows: assume that a secfc change relatng to a certan rsk (e.g. change of nterest rates or a change of equty rces or a change of mortalty rates) takes lace whle all arameters relatng to other rsks reman unchanged. Ths s the aroach that was aled n QIS4. Dscussons durng the exercse n some markets have shown that ths smle and straghtforward scenaro defnton may lead to unrealstc results whch do not fully reflect the rsk that the nsurers are exosed to. The followng examles should llustrate the ssue. Three examles for lase rsk trggered by other rsks Examle 1: Lase trggered by the reducton of bonus rates 3.113. In lfe wth-roft busness, many rsks can be mtgated by cuttng future bonuses. The QIS4 reort shows that the adjustment for the rsk mtgatng effect has a sgnfcant nfluence on the SCR n many countres. In the market wth the hghest mact, about 75% of the BSCR s reduced by the adjustment for the loss-absorbng caacty of techncal rovsons on average. Under the scenaro defnton outlned above, ths may be a far reflecton of the undertakng s roft sharng systems. 3.114. Nevertheless, for certan knds of busness the outcome aears to be unrealstc because a sgnfcant cut of future bonuses may change the lase behavour of olcyholders. For examle, consder a term nsurance where the extra beneft of the olces s used to reduce the remums. A sgnfcant cut of extra benefts as a reacton to (for nstance) an equty shock would ncrease the number of lases because many olcyholders would rather termnate the contract than ay a sgnfcantly hgher remum. The ncrease of lases would consequently ncrease the techncal rovsons because the busness s usually roftable and the future roft of the termnated treates cannot be taken nto account anymore n the rovson. Hence, the cut of extra benefts would trgger lases whch would at least artly thwart the mtgatng effect of roft sharng. 3.115. Ths effect was not taken nto account under the QIS4 scenaro aroach because t was assumed that lase rates are fxed n the equty scenaro. Moreover, ths effect s also not fully covered by the lase rsk module because frstly, the lase effect of the reducton n extra benefts can be hgher than the shocks consdered n the lase sub-module and secondly, there s a hgh dversfcaton effect between lase rsk and equty rsk n the standard formula. Accordng to Annex IV of the Level 1 text, the correlaton factor for market rsk and lfe underwrtng rsk s 25%. However, n the examle there s a causal connecton between equty rsk and lase rsk. 20/49

Examle 2: Lum-sum oton trggered by the ncrease of nterest rates 3.116. In deferred annuty nsurance, the olcyholder can often choose between a lum sum and a revously fxed annuty at exraton of the mortalty cover. The take-u rate for ths oton s very lkely to be nterest rate senstve. 3.117. If the market nterest rates are sgnfcantly lower than the techncal rate that was used to determne the annuty, t s ratonal for all olcyholders to choose the annuty. Therefore, n the nterest rate decrease, scenaro the number of olcyholders whch choose the annuty would go u, thereby ncreasng the loss of the nsurer. 3.118. On the other hand, f the market nterest rates are sgnfcantly hgher than the techncal rate more olcyholders are lkely to choose the lum sum. Therefore, n the scenaro of an nterest rate ncrease the reducton of techncal rovsons due to dscountng wth hgher rates may be artly countered by the loss of future roft. Nether of both effects s currently allowed for n the SCR. Examle 3: Reducton of nsurance cover trggered by the decrease of nterest rates n health nsurance 3.119. In health nsurance as descrbed n Artcle 204 of the Level 1 text (techncal bass smlar to that of lfe nsurance), the nsurer can adjust the remums accordng to a secfc mechansm n order to take nto account a change n rsk factors lke health exenses, longevty or nterest rates. For examle, under the nterest rate decrease scenaro, ths mechansm s usually aled to mtgate the stress. In lne wth the scenaro defnton outlned above, all other rsk factors reman unchanged. 3.120. However, n realty t s very lkely that the ncrease n remum levels would cause a art of the olcyholders to reduce ts nsurance cover to comensate for the fnancal stran. Ths would reduce the future rofts and therefore reduce the mtgatng effect of the remum ncrease. 3.121. Smlar effects may exst n relaton to other knds of nsurance wth adjustable remums. 3.122. Summarsng, the three examles dffer n both the trggerng event as well as the oton that they affect: Examle Trggerng event Oton affected 3.113 bonus rate reducton lase 3.116 change n nterest rate lum sum oton 3.119 remum adjustment reducton of nsurance cover 3.123. An nsuffcent allowance for lase rsk n the SCR standard formula has also been noted by stakeholders. It was crtcsed that the man rsk n lfe nsurance s not taken nto account n the standard formula, namely a olcyholder run touched-off by market, credt, or oeratonal rsk. 21/49

Lase trggered by deteroraton of fnancal oston 3.124. Another mortant external trgger of olcyholder acton s the deteroraton of the undertakng s fnancal oston. Such an event, f t becomes aarent, may cause a mass lase ncdent, thereby renforcng the declne of the fnancal oston. Proosal to allow for lase rsk n the SCR scenaros 3.125. The examles demonstrate that the QIS4 aroach to lase rsk (and other oton take-u rsks) does not take nto account that the take-u of the oton by the olcyholder may be trggered by other rsks or the reacton of the nsurer to other rsks. On the contrary, the QIS4 standard formula makes the assumton that lase rsk s aroxmately ndeendent from other rsks. 11 Dsregardng the deendence of oton take-us and other rsks may lead to a sgnfcant underestmaton of the 99.5% confdence level of the SCR. 3.126. It seems that ths defcency cannot be elmnated by an ncrease of the correlaton factors that are used to aggregate lase rsk and the other rsks. In order to model a hgh deendence between lase rsk and, for examle, nterest rate rsk n the current modular structure of the SCR, the correlaton factor for market and lfe underwrtng rsk must be ncreased. But ths would also ncrease the modelled deendence between market rsk and mortalty rsk, longevty rsk and CAT rsk although these rsks are lkely to be less deendent. Hence, an ncrease of the correlaton factors may artly remedy the defcency n relaton to lase rsk, but would lead to an unjustfed ncrease of the deendence between other rsks. 3.127. Another way to tackle the roblem would be to relax the scenaro defnton aled n the SCR calculatons. Instead of changng one arameter (e.g. nterest rates) n the scenaro and keeng all other arameters fxed, the scenaro could also allow for adverse changes n oton take-u rates. For nstance, the nterest rate decrease scenaro (net of roft sharng) could be defned as follows: nmkt nt Down = NAV downwardshock, where NAV downwardshock s the change n the net value of asset and labltes due to revalung all nterest rate senstve nstruments usng altered term structures. The revaluaton s done under the condton that the artcant s able to vary ts assumtons on future bonus rates n resonse to the shock. Moreover, the revaluaton should allow for any relevant adverse changes n oton take-u behavour of olcyholders n ths scenaro. 11 In the QIS4 lfe underwrtng rsk module, there s a correlaton factor of 0.25 n relaton to longevty and 0.5 n relaton to exenses. In relaton to mortalty, dsablty and CAT rsk a factor of 0 was chosen. Accordng to Annex IV of the Level 1 text, the correlaton factor for lfe underwrtng rsk and market rsk s 0.25. 22/49

Practcablty of the roosal 3.128. The roosal should not to cause ractcal roblems. In rncle, the undertakng already needs to make assumtons about the behavour of ts olcyholders n extreme scenaros n order to calculate the value of otons and guarantees for the best estmate rovsons accordng to Artcle 78 of the Level 1 text. Consstent assumtons can be used n the SCR scenaros to allow for changed olcyholder behavour. In case an aroxmaton s used to value the otons and guarantees, t should be ossble to derve assumtons about the stressed oton-take u rates whch are consstent wth the aroxmatons. Nevertheless, n some cases t may be helful to gve market-secfc actuaral gudance about the olcyholder behavour n relaton to certan roducts n order to ensure the ractcablty and comarablty of the SCR calculatons. 3.129. In lne wth the roortonalty rncle, the roosal ncludes only the relevant changes n oton take-u rates. Relaton to the lase rsk sub-module 3.130. Accordng to the roosal, lase rsk s allowed for twce n the SCR standard formula: n the lase rsk sub-module and n each scenaro whch has a relevant adverse effect on the lase rates. However ths does not gve rse to a double countng of lase rsks. 3.131. Concetually, two elements of lase rsk can be dstngushed: A. Msestmate of current lase rates A msestmate of the lase rates whch are arorate (ths year and n future years) accordng to the current stuaton (.e. the current nterest rates, bonus rates etc.). B. Change of lase rates The change of lase rates owng to a change of the current stuaton (.e. a change n nterest rates, bonus rates etc.). The examles gven n aragrahs 3.113 to 3.123 llustrate ths rsk. 3.132. An allowance for lase rsk n the SCR scenaros as roosed above would only cover lase rsk of tye B. Besdes, t would not fully cover ths knd of lase rsk because not all ossble changes of the current stuaton whch affect the lase rates are reflected n SCR. For nstance, the effect descrbed n the examle of aragrah 3.123 s not covered by the SCR scenaros. 3.133. Comlementary to ths aroach, the lase sub-module of the lfe underwrtng rsk module allows for the resdual lase rsk of tye B as well as the comlete lase rsk of tye A. Therefore, the roosal does not lead to double countng of lase rsk. However, the calbraton of the lase scenaros n the lase sub-module, n artcular of the mass lase event, should take nto account the dstncton made aragrah 3.131. 23/49

Scoe of the lase rsk sub-module 3.134. Accordng to Artcle 105(3f) of the Level 1 text, the lase rsk sub-module covers the rsk of loss, or of adverse change n the value of nsurance labltes, resultng from changes n the level or volatlty of the rates of olcy lases, termnatons, renewals and surrenders (lase rsk) 3.135. Ths descrton does not fully clarfy whch olcyholder otons are ncluded n the sub-module. In artcular, the scoe of the terms lase, termnaton and surrender s not clear. For examle, n QIS4 the rsk relatng to changes to ad-u status were ncluded n the sub-module because t was nterreted as a artal termnaton. The scoe of the module should be clarfed at Level 2 n order to remove otental ambguty n the calculaton of the lase rsk catal requrement. 3.136. There are two ossble antodal aroaches to the scoe of the lase rsk module: A narrow defnton of the scoe: only those otons are ncluded whch ether fully renew the nsurance cover or whch fully termnate the olcy and whch are defned as surrender or lase otons n the terms and condtons of the olcy. A wde defnton of the scoe: all otons are ncluded where a take-u or non take-u reduces the nsurance cover. 3.137. There s a range of ossble defntons between these antodal aroaches. 3.138. The narrow defnton would not nclude, for examle, changes to ad-u status. If the narrow defnton s aled t may be advsable to add further sub-modules to the lfe underwrtng rsk module n order to cover the rsk of other otons. Moreover, wth the narrow defnton arbtrage oortuntes aear to be unavodable. Polcyholder otons whch slghtly dffer n ther effect or descrton may be treated dfferently n the SCR calculaton. For examle, a artal termnaton oton whch reduces the nsurance cover by 99% s not ncluded n the narrow defnton although the economc effect s comarable to a full termnaton whch s ncluded. 3.139. On the other hand, a wde defnton could be a clear and smle way to cover all materal oton rsks consstently wthn the structure of the standard formula. It would not be necessary to add further sub-modules to the lfe underwrtng modules whch cover other oton rsks. Therefore, the wde defnton s referable. 3.140. Under the wde defnton of scoe, the scenaros whch defne a ermanent decrease and ncrease of oton take-u rates could be defned as follows: laseshock down = Reducton of x% n the assumed oton take-u rates n all future years for all olces wthout a ostve surrender stran or otherwse adversely affected by such rsk. Affected by the reducton are otons to fully or artly termnate, decrease, restrct or susend the nsurance cover. Where an oton allows the full or artal establshment, renewal, ncrease, 24/49

laseshock u extenson or resumton of nsurance cover, the x% reducton should be aled to the rate that the oton s not taken u. = Increase of y% n the assumed oton take-u rates n all future years for all olces wth a ostve surrender stran or otherwse adversely affected by such rsk. Affected by the ncrease are otons to fully or artly termnate, decrease, restrct or susend the nsurance cover. Where an oton allows the full or artal establshment, renewal, ncrease, extenson or resumton of nsurance cover, the y% ncrease should be aled to the rate that the oton s not taken u. 3.141. The surrender stran of a olcy s defned as the dfference between the amount currently ayable on surrender and the best estmate rovson held. The amount ayable on surrender should be calculated net of any amounts recoverable from olcyholders or agents e.g. net of any surrender charge that may be aled under the terms of the contract. Catal requrements for the three sub-rsks (see aragrah 3.142) should be calculated based on a olcy-by-olcy comarson of surrender value and best estmate rovson. In ths context, the term surrender should refer to all knd of olcy termnatons rresectve of ther name n the terms and condtons of the olcy. In artcular, the surrender value may be zero f no comensaton s ad on termnaton. Calculaton of the catal requrement 3.142. The calculaton of the catal requrement for lase rsk n QIS4 was based on three scenaros: a ermanent ncrease of lase rates; a ermanent decrease of lase rates; and a mass lase event. 3.143. The catal requrement was obtaned as the loss of net asset value under the most adverse of the three scenaros. Ths smle aroach has some shortcomngs. For examle, an nsurer may be exosed to the rsk of an ncrease n lase rates on one art of ts ortfolo and a decrease of lase rates n another art of the ortfolo. Such stuatons are not covered by the aroach. However, wthn the natural lmtatons of the standard formula the QIS4 aroach aears to be an accetable soluton. The feedback from the QIS4 artcants gves no other ndcaton. Calbraton Calbraton of laseshock u and laseshock down 3.144. As lase rates are not frequently used for reservng under Solvency I, the emrcal bass for a calbraton of the ermanent shocks laseshock u and laseshock down s oor for most markets. 25/49

3.145. The QIS4 calbraton of the shocks was based on a study of the UK wthroft lfe nsurance market n 2003 erformed by order of the Brtsh FSA. 12 The analyss resulted n estmates for quantles of ermanent lase rate decreases as follows: Quantle Relatve change of lase rate 90% -28.5% 91% -29.3% 92% -30.3% 93% -31.7% 94% -33.0% 95% -34.5% 97.5% -39.0% 3.146. The quantle roduced n the study are lower than the Solvency II confdence level of 99.5%. Nevertheless, by extraolaton of the above values, the QIS4 calbraton of -50% can be justfed. The study does not cover the rsk of a ermanent ncrease of lase rates, however, n absence of better evdence t s arorate to assume a symmetrcal stresses for both scenaros and choose +50% for the ncrease scenaro. 3.147. CEIOPS has looked for further evdence from other markets. An analyss of the Polsh suervsor on the natonal lfe nsurance market suorts the above calbraton assumtons (see Annex C). The study shows that the 99.5% quantle of annual lase rate devatons from a long-term mean s between 60% and 100% for ncreases and between -60% and -90% for decreases. As these values are based on an annual devaton they overestmate the shock of a ermanent change. However, the results ndcate that the range of the roosed calbraton s arorate. 3.148. The lase shocks were calbrated on small rates. If the rates are much larger, the calbraton may roduce excessve results. Moreover, t needs to be avoded that the shocked rates exceed 100%. 3.149. Therefore, the shocked take-u rate should be restrcted as follows: R u ( R) = mn(150% R;100%) and R down ( R) = mn(max(50% R; R 20%),0), where 12 Fnancal Servces Authorty»Calbraton of the Enhanced Catal Requrement for wth-rofts lfe nsurers«, 2004 (htt://www.fsa.gov.uk/ubs/olcy/04_16/ww_reort.df). 26/49

R u R down R = shocked take-u rate n laseshock u = shocked take-u rate n laseshock down = take-u rate before shock Calbraton of the mass lase event 3.150. The scenaro shocks laseshock u and laseshock down cover the rsk of a msestmaton or of a ermanent change of lase rates. By contrast, the mass lase event covers the rsk of a temorary and drastc rse of lase rates. The lkelness that olcyholders termnate ther olces s ncreased for a lmted san of tme. The cause for ths change n olcyholder behavour can be of an nternal or external nature. An nternal cause could, for examle, be the deteroraton of the fnancal oston of the undertakng or any other event that sgnfcantly affects the reutaton of the undertakng or the grou t belongs to. Examles of external events would be changes n the economc stuaton or changes n the tax regulatons that drectly or ndrectly affect the olces of the undertakng. An event n the bankng sector comarable to the mass lase event would be a bank run. 3.151. The calbraton of the mass lase event should account for the scenaro defnton as defned above (aragrah 3.111 ff.). Where the change n lase behavour s trggered by a change n scenaro-based rsk lke nterest rate rsk or equty rsk, an allowance n the mass lase event s not necessary. The calbraton of the mass lase event should only cover those changes n behavour whch are not trggered by these rsks. 3.152. On the other hand, the calbraton of the mass lase event has to reflect the fact that mass lase s a catastrohe tye event. 13 Polcyholder behavour under extreme condtons s dffcult to assess as t can be determned by comlex henomena lke herd behavour and selfrenforcng mechansms. Exerence from the bankng sector durng the current fnancal crses shows (for examle Northern Rock bank run n 2007) that olcyholder behavour can ose a sgnfcant rsk to fnancal nsttutons. 3.153. Under Solvency I nsurance and rensurance undertakngs are less affected by lase rsk as the techncal rovsons for a olcy must not be lower than ts surrender value. But under Solvency II t may haen that the assets of an undertakng do not cover the surrender values. Such nsurers are hghly vulnerable to mass lase events, n artcular when ther stuaton becomes ublc. 3.154. The emrcal bass to calbrate the mass lase event s oor. In the absence of better evdence, CEIOPS rooses to mantan the QIS4 calbraton of 30% of the sum of ostve surrender strans. 3.155. It has been dscussed whether dfferent tyes of lfe nsurance olces are affected dfferently by mass lase events: roducts wth sgnfcant 13 The nature of the catastrohe event n the lase rsk sub-module s clearly dstnct from the nature of the catastrohe events n the lfe CAT rsk sub-module. 27/49

guarantees lke wth-roft roducts may show a hgher ersstency than roducts wth low guarantees lke many unt-lnked olces. 3.156. On the other hand, for non- retal busness 14, the rsk of a mass lase s substantally greater for the followng reasons: Insttutonal nvestors tend to be better nformed and would be quck to wthdraw funds f there was any queston over the solvency of a frm, artcularly f they were aware that the frm dd not have suffcent funds to meet all clams; There are generally no surrender enaltes. 3.157. CEIOPS therefore beleves that a hgher calbraton of the mass lase stress s arorate for ths busness. In the absence of other nformaton, CEIOPS rooses to use the QIS3 calbraton of 70% of the sum of ostve surrender strans. 3.158. At ths stage, takng nto account a smle valuaton of the mass lase event, CEIOPS s consderng whether to dfferentate further between dfferent nsurance roducts for the uroses of the mass lase stress. Smlfcatons Calculaton on olcy-by-olcy bass 3.159. In case the best estmate s calculated on the bass of homogeneous rsk grous nstead of on a olcy-by-olcy bass, the determnaton of the surrender stran as defned n aragrah 3.141 may be burdensome and not necessary to arrve at a suffcently accurate catal requrement. Therefore, f t s roortonate to the nature, scale and comlexty of the rsk, the comarson of surrender value and best estmate rovson mght be made on the level of homogeneous rsk grous nstead of a olcy-byolcy bass. 3.160. As the calculaton on a homogeneous rsk grou level s lkely to result n the same or a lower catal requrement than the olcy-by-olcy calculaton, t seems necessary to set u crtera for ts alcaton. A calculaton on the level of homogeneous rsk grous should be consdered to be roortonate f: (a) the homogeneous rsk grous arorately dstngush between olces of dfferent lase rsk; (b) the result of a olcy-by-olcy calculaton would not dffer materally from a calculaton on homogeneous rsk grous; and (c) a olcy-by-olcy calculaton would be an undue burden comared to a calculaton on homogeneous rsk grous whch meet crtera (a) and (b). 14 Non-retal busness covers enson fund management as descrbed n Artcle 2(3) and s a secfed class of long term nsurance busness. It falls wthn Artcle 2(3)(b)() where t smly nvolves the management of nvestments and assets reresentng the reserves of bodes that effect ayments on death or survval or n the event of dscontnuance or curtalment of actvty. It falls wthn Artcle 2(3)(b)(v) where t s also combned wth nsurance coverng conservaton of catal. The nsurance coverng conservaton of catal could be lnked busness. In that case, the undertakng would be carryng on both Class VII (enson fund management) and Class III (lnked long term). In addton, non retal busness covers busness fallng wthn Class III of Annex II, where the olcyholder s a erson other than a natural erson. 28/49

Factor-based formula for scenaro effect 3.161. For the two scenaro calculatons laseshock down and laseshock u, factorbased smlfcatons were rovded n QIS4. These smlfcatons attemt to aroxmate the effect of the ermanent change of lase rates by rojecton of the effect of a temorary shock nto the future. The effect of a temorary change n lase rates can easly be measured by means of the surrender stran: for examle, the loss ncurred n a ortfolo wth ostve surrender stran due to temorary change of lase rates by 5 ercentage onts s aroxmately 5% of the surrender stran. In order to for the ermanence of the change n the scenaros laseshock down and laseshock u, ths loss can be multled wth the duraton of the ortfolo n queston. 3.162. Ths aroach results n formulas as follows: Lase and Lase where down u = 50 % l u down u n down = 50 % l n S, u S down l down; l u = estmate of the average rate of lasaton of the olces wth a negatve/ostve surrender stran n down; n u = average erod (n years), weghted by surrender strans, over whch the olcy wth a negatve/ostve surrender stran runs off S down; S u = sum of negatve/ostve surrender strans 3.163. The smlfed calculaton should be done at an arorate granularty. 3.164. The factor-based aroxmatons should only be used f they are roortonate to the nature, scale and comlexty of the rsk. In artcular, as an alcaton of the scale crteron of the roortonalty rncle, the smlfcaton should only be used f the catal requrement for lase rsk (determned wth the smlfcaton) s small comared to the overall catal requrement. A threshold of 5% of the overall SCR (before adjustment for the loss-absorbng caacty of techncal rovsons and deferred taxes) was tested n QIS4 and aears to be arorate. Moreover, the smlfcaton should only be used, f the more sohstcated result of the scenaro analyss s not easly obtanable. 3.7.2 CEIOPS advce Treatment of lase rsk n the scenaro calculatons 3.165. In the scenaro calculatons of the SCR standard formula, the revaluaton of techncal rovsons should allow for relevant adverse changes n oton take-u behavour of olcyholders under the secfed scenaro. Scoe of the lase rsk sub-module 3.166. In relaton to the olcyholder otons that the lase sub-module covers, a 29/49

account of all legal or contractual olcyholder otons whch can sgnfcantly change the value of the future cash-flows. Ths ncludes otons to fully or artly termnate, decrease, restrct or susend the nsurance cover as well as otons whch allow the full or artal establshment, renewal, ncrease, extenson or resumton of nsurance cover. 3.167. In the followng, the term lase s used to denote all these olcyholder otons. Calculaton of the catal requrement n the lase rsk sub-module 3.168. Based on the assumtons contaned n the exlanatory text, CEIOPS has calbrated the sub-module accordng to 99.5% VaR and a one year tme horzon. 3.169. The catal requrement for lase rsk should be calculated as follows: Lfe = max( Lase ; Lase ; Lase ), lase where Lfe lase Lase down Lase u Lase mass down u mass = Catal requrement for lase rsk = Catal requrement for the rsk of a ermanent decrease of the rates of lasaton = Catal requrement for the rsk of a ermanent ncrease of the rates of lasaton = Catal requrement for the rsk of a mass lase event 3.170. Catal requrements for the three sub-rsks should be calculated based on a olcy-by-olcy comarson of surrender value and best estmate rovson. The surrender stran of a olcy s defned as the dfference between the amount currently ayable on surrender and the best estmate rovson held. The amount ayable on surrender should be calculated net of any amounts recoverable from olcyholders or agents e.g. net of any surrender charge that may be aled under the terms of the contract. In ths context, the term surrender should refer to all knd of olcy termnatons rresectve of ther name n the terms and condtons of the olcy. In artcular, the surrender value may be zero f no comensaton s ad on termnaton. 3.171. The catal requrement for the rsk of a ermanent decrease of the rates of lasaton should be calculated as follows: Lase down = NAV laseshock down, where NAV = Change n the net value of assets mnus labltes (not ncludng changes n the rsk margn of techncal rovsons where t needs to be calculated searately) laseshock down = Reducton of 50% n the assumed oton take-u rates n all future years for all olces wthout a ostve surrender stran or otherwse adversely 30/49

affected by such rsk. Affected by the reducton are otons to fully or artly termnate, decrease, restrct or susend the nsurance cover. Where an oton allows the full or artal establshment, renewal, ncrease, extenson or resumton of nsurance cover, the 50% reducton should be aled to the rate that the oton s not taken u. The shock should not change the rate to whch the reducton s aled to by more than 20% n absolute terms. 3.172. The catal requrement for the rsk of a ermanent ncrease of the rates of lasaton should be calculated as follows: Lase u = NAV laseshock u, where NAV = Change n the net value of assets mnus labltes (not ncludng changes n the rsk margn of techncal rovsons where t needs to be calculated searately) laseshock u = Increase of 50% n the assumed oton take-u rates n all future years for all olces wth a ostve surrender stran or otherwse adversely affected by such rsk. Affected by the ncrease are otons to fully or artly termnate, decrease, restrct or susend the nsurance cover. Where an oton allows the full or artal establshment, renewal, ncrease, extenson or resumton of nsurance cover, the 50% ncrease should be aled to the rate that the oton s not taken u. The shocked rate should not exceed 100%. 3.173. Therefore, the shocked take-u rate should be restrcted as follows: R u ( R) = mn(150% R;100%) and R down ( R) = mn(max(50% R; R 20%),0), where R u = shocked take-u rate n laseshock u R down R = shocked take-u rate n laseshock down = take-u rate before shock 3.174. The catal requrement for the rsk of a mass lase event Lase mass should be defned as 30% of the sum of surrender strans over the olces where 31/49

the surrender stran s ostve. 3.175. For non-retal busness (see aragrah 3.156), the catal requrement for the rsk of a mass lase event Lase mass should be defned as 70% of the sum of surrender strans over the olces where the surrender stran s ostve. Smlfcatons Calculaton on olcy-by-olcy bass 3.176. If t s roortonate to the nature, scale and comlexty of the rsk, the comarson of surrender value and best estmate rovson referred to n aragrah 3.170 mght be made on the level of homogeneous rsk grous nstead of a olcy-by-olcy bass. A calculaton on the level of homogeneous rsk grous should be consdered to be roortonate f (a) the homogeneous rsk grous arorately dstngush between olces of dfferent lase rsk; (b) the result of a olcy-by-olcy calculaton would not dffer materally from a calculaton on homogeneous rsk grous; and (c) a olcy-by-olcy calculaton would be an undue burden comared to a calculaton on homogeneous rsk grous whch meet crtera (a) and (b). Factor-based formula for scenaro effect 3.177. A smlfed calculaton of Lase down and Lase u as defned n aragrah 3.178 may be made f the followng condtons are met: (d) The smlfed calculaton s roortonate to nature, scale and comlexty of the rsk. (e) The catal requrement for lase rsk under the smlfed calculaton s less than 5% of the overall SCR before adjustment for the lossabsorbng caacty of techncal rovsons and deferred taxes. For ths comarson the overall SCR can be calculated by means of the smlfed calculaton for the lase rsk catal requrement. (f) The quantfcaton of the scenaro effect defned n aragrahs 3.171 and 3.172 would be an undue burden. 3.178. The smlfed calculatons are defned as follows: Lase and Lase where down u = 50 % l u down u n down = 50 % l n S, u S down l down; l u = estmate of the average rate of lasaton of the olces wth a negatve/ostve surrender stran n down; n u = average erod (n years), weghted by surrender strans, over whch the olcy wth a negatve/ostve surrender stran runs off 32/49

S down; S u = sum of negatve/ostve surrender strans 3.179. The smlfed calculaton should be done at an arorate granularty. 3.180. Note that under the smlfcaton, the constrant to look at Lase down, Lase u, and mass Lase stll ales. 3.8 Lfe catastrohe rsk 3.8.1. Exlanatory text Introducton 3.181. Catastrohe rsk stems from extreme or rregular events whose effects are not suffcently catured n the other lfe underwrtng rsk sub-modules. Examles could be a andemc event or a nuclear exloson. 3.182. Ths rsk s normally treated by usng a one-off extreme mortalty and/or morbdty rate. 3.183. Catastrohe rsk s manly assocated wth roducts (such as term assurance, crtcal llness or endowment olces) n whch a comany guarantees to make a sngle or recurrng & erodc seres of ayments when a olcyholder des or s dagnosed wth a secfed dsease wthn a re-agreed erod. Lfe catastrohe rsk n QIS4 3.184. The QIS4 aroach to the SCR standard formula ncluded a catastrohe rsk sub-module n the lfe underwrtng rsk module (secton TS.XI.H of the QIS4 Techncal Secfcatons (MARKT/2505/08)). The calculaton of the catal requrement for catastrohe rsk was a scenaro based stress. The scenaro tested was a combnaton of the followng events: an absolute 1.5 er mlle ncrease n the rate of olcyholders dyng over the followng year (e.g. from 1.0 er mlle to 2.5 er mlle) an absolute 1.5 er mlle ncrease n the rate of olcyholders exerencng morbdty over the followng year. Where arorate, undertakngs should assume that one-thrd of these olcyholders exerence morbdty for 6 months, one-thrd for 12 months and onethrd for 24 months from the tme at whch the olcyholder frst becomes sck. 3.185. The followng comments were made by QIS4 artcants wth regard to the catastrohe rsk stress: An nconsstency was noted between the full and smlfed standard SCR aroaches for Cat rsk: whereas the full aroach allows a negatve contrbuton from annuty busness, ths s not ossble under the smlfed methodology. The "olcy by olcy" calculaton for the assessment of the Lfe Lase and Lfe Cat rsk s consdered too burdensome for many undertakngs. 33/49

Calculaton of the catal requrement 3.186. QIS4 artcants dd not comment on the general methodology of the mortalty catastrohe stress and CEIOPS has therefore concluded that the aroach adoted n QIS4 was sutable. 3.187. Therefore the catal requrement should be calculated as the change n net asset value (assets mnus labltes) followng an absolute ncrease n the rate of olcyholders dyng over the followng year of x er mlle. 3.188. Wth regard to the morbdty catastrohe stress, CEIOPS has consdered further the modellng of health catastrohe rsk as art of the develoment of the health underwrtng module. There s a wde varety of health roducts wrtten across Member States and CEIOPS beleves that t s not ossble to defne a sngle stress whch catures the catastrohe rsk assocated wth dfferent roducts. Therefore a number of an Euroean catastrohe scenaros wll be develoed for health busness. For further nformaton on ths rocess, lease refer to CEIOPS advce on non lfe catastrohe rsk. 3.189. In lght of the above, CEIOPS rooses to remove the morbdty catastrohe stress from the lfe underwrtng module. However frms wll be exected to consder the extent to whch any of the health catastrohe stresses are alcable for ther busness frm and, f so, aly these stresses n addton to the mortalty catastrohe stresses defned above. Correlatons between lfe and health catastrohe rsk wll be consdered n a later aer. Calbraton of the lfe catastrohe stress 3.190. The QIS4 calbraton of the mortalty catastrohe stress was suorted by a study carred out by Swss Re 15 n 2007 whch estmated that the 1 n 200 year andemc stress for most develoed countres s between 1.0 and 1.5 er mlle wthn nsured lves. Ths study was based on a sohstcated edemologcal model. 3.191. However, there are a number of otental weaknesses n ths model such as not adequately allowng for the robablty of flu jumng across seces such as from brds to humans, not allowng for non-nfluenza andemcs (e.g. AIDS, drug resstant TB, Ebola vrus / MRSA / SARS) or other causes of mortalty catastrohe such as terrorsm or hyscal catastrohes such as earthquakes. If these weaknesses were addressed, t s lkely that the estmated stress would ncrease. 3.192. Furthermore, due to sarse hstorcal data on andemcs, there s a sgnfcant degree of uncertanty around the calbraton of any andemc model. 3.193. We also note that the 1918 flu andemc, whch s the most sgnfcant mortalty catastrohe for whch data s avalable, gave rse to death levels of above 5 er mlle. 3.194. The above roosal does not restrct the alcaton of the catastrohe module to (re)nsurance oblgatons whch are contngent n mortalty.e. the module may also be aled to (re)nsurance oblgatons, such as 15 htt://www.swssre.com/resources/bbab850046606bf6b89cfd276a9800c6-shan- 753GRL_Pandemc%20nfluenza.df 34/49

annutes, where the ncrease n mortalty leads to a reducton n techncal rovsons. 3.195. Although ths may seem to reflect the economc substance of (re)nsurance undertakngs' ortfolos by allowng for the dversfcaton between dfferent lnes of busness, there s evdence to suggest that ths dversfcaton beneft may not exst n realty. In artcular, hstorc data ndcates that rmarly young and healthy eole ded as a result of nfluenza andemcs. 3.196. CEIOPS s therefore roosng the restrcton of the mortalty catastrohe module to (re)nsurance oblgatons whch are contngent on mortalty.e. where an ncrease n mortalty leads to an ncrease n techncal rovsons. 3.197. CEIOPS beleves that ths restrcton would mean that s s reasonable to consder a lower calbraton of the mortalty catastrohe stress. 3.198. For jont lfe olces, the mortalty catastrohe loadng should be aled searately for each nsured erson, rather than on a 'er olcy' bass. 3.199. Therefore a mortalty catastrohe stress consttutng an absolute ncrease of 1.5 er mlle s roosed. 3.8.2. CEIOPS advce Catastrohe rsk 3.200. Based on the assumtons contaned n the exlanatory text, CEIOPS has calbrated the sub-module accordng to 99.5% VaR and a one year tme horzon. 3.201. The calculaton of the catal requrement for catastrohe rsk shall be a scenaro based stress. 3.202. The mortalty catastrohe module s restrcted to (re)nsurance oblgatons whch are contngent on mortalty,.e. where an ncrease n mortalty leads to an ncrease n techncal rovsons. 3.203. The catal requrement shall be calculated as the change n net asset value (assets mnus labltes) followng an absolute ncrease n the rate of olcyholders dyng over the followng year of 1.5 er mlle. 3.204. (Re)nsurance undertakngs shall also be requred to consder whether any of the catastrohe scenaros defned as art of the health catastrohe module are alcable for the busness covered by the lfe underwrtng module. Where ths s the case, (re)nsurance undertakngs shall be requred to aly these stresses n addton to the mortalty catastrohe stress. 35/49

Annex A Estmate of the volatlty n dsablty ncdence and recovery (Swedsh FSA) Incdence A.1. A.2. The total ncdence rate n terms of ncurred and IBNR rovsons for new clams has been recorded as a roorton of total volume of actve (nonncurred) nsurance busness, for a number of comanes and for u to 6 years (2002-2007). The fgures also nclude waver-of remum nsurance. The coeffcent of varaton (standard devaton dvded by average) has been calculated for each comany. The results are gven n the followng table. Incdence Var-coeff Comany 1 46% Comany 2 26% Comany 3 127% Comany 4 16% Comany 5 55% Comany 6 69% Comany 7 36% Comany 8 2% Comany 9 31% Comany 10 65% Comany 11 160% Comany 12 89% Comany 13 193% Comany 14 59% Comany 15 36% Comany 16 102% Comany 17 82% Comany 18 27% Comany 19 23% Comany 20 51% Comany 21 76% Comany 22 56% 36/49

Reservaton A.3. The fgures are based uon annual reorts from the comanes. The qualty of data n some cases may be low. The conclusons must therefore be taken wth some consderaton. Conclusons A.4. A.5. A.6. The data shows that the annual varaton n ncdent rates ranges from 23% to 127% (dscardng outlers) for dfferent comanes. It s mortant to note that dsablty nsurance n Sweden s sulementary to socal securty nsurance and there s lttle room for undertakngs to aly ther own judgement n resect of clams. Durng the erod of the study, there was a sgnfcant trend movng from strong negatve outcomes towards strong ostve outcomes because of dfferent management actons. Ths has been caused by lmtatons to olcy condtons combned wth external oltcal decsons, for examle the defnton of acceted dsablty reasons and clams erods has been changed. Other external crcumstances, for nstance unemloyment, could also have a sgnfcant mact on ncdence rates. Snce such crcumstances may also occur n future, we beleve that the nceton rate for the frst year may reasonably be stressed by as much as + 50 %. Recovery A.7. The total recovery rate (ncludng mortalty) has been recorded n terms of rovsons released as a result of recovery as a roorton of total rovsons for n resect of dsablty for a number of comanes and for u to 6 years (2002-2007). We have calculated the coeffcent of varaton (standard devaton dvded by average) for every comany. The results are gven n the followng table. Recovery Varcoeff Comany 1 126% Comany 2 146% Comany 3 69% Comany 4 35% Comany 5 36% Comany 6 4% Comany 7 95% Comany 8 31% Comany 9 51% 37/49

A.8. Due to the uncertanty n the data qualty, data from only 9 comanes has been used n the nvestgaton. Conclusons A.9. The reservatons descrbed above also aly n resect of the analyss of recovery rates. A.10. The data shows that the annual varaton n recovery rates ranges from 31% to 126% (dscardng outlers) for dfferent comanes. A.11. It s clear that there s sgnfcant uncertanty n the estmate of the termnaton rates. Although the relatonsh s not straghtforward, we beleve there s suffcent reason to stress ths robablty by as much as 20%. 38/49

Annex B Longevty rsk calbraton analyss B.1. B.2. For the urose of the longevty rsk calbraton, CEIOPS has conducted two analyses: hstorc mrovements n mortalty rates, shocks of future mrovements n mortalty rates. The analyses are based on the unsex mortalty tables for 9 countres (DE, FR, England & Wales, ES, IT, SE, PL, HU, CZ) from 1992 tll 2006 (15 years) from data avalable at www.mortalty.org. Hstorc mrovements n mortalty rates B.3. CEIOPS has analysed hstorc mrovements n mortalty rates from 1992 to 2006 as well as for shorter ntervals (from 1992 to 1999 and from 1999 to 2006). The results of ths analyss are resented below: Age band Table 1. Imrovements n mortalty rates from 1992 to 2006 Average DE FR UK 16 ES IT SE PL HU CZ 30-39 -39% -46% -40% -9% -46% -45% -34% -34% -55% -38% 40-49 -25% -28% -19% -12% -19% -29% -31% -26% -28% -35% 50-59 -22% -22% -13% -23% -19% -30% -23% -19% -17% -29% 60-69 -29% -32% -25% -34% -26% -35% -27% -26% -22% -32% 70-79 -27% -30% -25% -29% -26% -31% -25% -28% -22% -30% 80-89 -20% -22% -24% -19% -18% -23% -16% -22% -20% -20% 90-99 -11% -7% -15% -6% -9% -14% -6% -15% -21% -10% Age band Table 2. Imrovements n mortalty rates from 1992 to 1999 Average DE FR UK 17 ES IT SE PL HU CZ 30-39 -22% -28% -26% -4% -21% -23% -21% -20% -30% -25% 40-49 -11% -13% -6% -4% -6% -15% -13% -15% -7% -22% 50-59 -13% -16% -9% -12% -9% -14% -15% -13% -11% -17% 60-69 -14% -16% -11% -17% -9% -17% -15% -12% -10% -20% 70-79 -10% -14% -8% -8% -7% -12% -12% -10% -5% -13% 80-89 -8% -11% -8% -4% -3% -11% -5% -8% -8% -10% 90-99 -2% -3% -1% -6% 2% -4% -1% -3% 0% 0% Age band Table 3. Imrovements n mortalty rates from 1999 to 2006 Average DE FR UK 18 ES IT SE PL HU CZ 30-39 -22% -24% -19% -5% -32% -28% -16% -18% -36% -18% 16 England&Wales 17 England&Wales 18 England&Wales 39/49

40-49 -16% -17% -15% -8% -14% -17% -21% -14% -23% -17% 50-59 -10% -7% -4% -13% -11% -18% -10% -8% -7% -15% 60-69 -17% -19% -16% -21% -18% -22% -13% -16% -13% -15% 70-79 -20% -19% -19% -23% -20% -22% -15% -20% -18% -20% 80-89 -14% -12% -18% -15% -16% -14% -11% -15% -14% -11% 90-99 -6% -4% -14% -11% -11% -10% -4% -12% 21% -10% Shocks of future mrovements n mortalty rates B.4. B.5. CEIOPS has also bult a stochastc model to carry out redcton of future mrovements n mortalty rates. The model s smlar to the stochastc model resented by Towers Perrn to the UNESPA 19. CEIOPS has calculated the mean and standard devaton of annual unsex mortalty mrovements n years 1992-2006 for each age for 9 countres. Assumng annual mortalty mrovements follow a Normal dstrbuton 20, CEIOPS has smulated future mortalty rates (1 000 smulatons for each country). For each smulaton CEIOPS buld rosectve mortalty tables. Once these smulatons have been carred out for dfferent duratons, CEIOPS comared the mean and the 99.5% ercentle of the robablty that someone aged x (x from gven age band) wll survve for t more years (t from coverage duraton) - rojected mortalty mrovement shock. Then CEIOPS transformed ths shock to an equvalent one-off shock (a ermanent change n mortalty rates for each age) that robabltes that someone aged x wll survve for t more years n one-off shock and n rojected mortalty mrovement shock are the same. Table 4. Average one-off shocks for future mrovements n mortalty rates accordng to age of nsured erson and outstandng duraton of the contract. Age band Coverage duraton 5 10 15 20 25 30 WL 21 20-24 -18.2% -17.0% -17.1% -15.7% -15.6% -15.5% -21.8% 25-29 -17.6% -17.0% -15.0% -14.1% -14.6% -14.6% -20.9% 30-34 -16.6% -14.2% -13.2% -13.4% -13.5% -13.0% -20.1% 35-39 -13.3% -11.9% -12.0% -12.5% -11.9% -10.8% -19.1% 40-44 -11.0% -11.1% -11.7% -11.1% -10.1% -9.1% -18.3% 45-49 -10.7% -11.0% -10.1% -9.3% -8.2% -11.8% -16.9% 50-54 -11.2% -9.7% -8.4% -7.5% -11.2% -15.1% -15.4% 55-59 -9.3% -7.9% -7.2% -11.1% -14.5% -18.1% -15.1% 60-64 -7.3% -6.4% -10.8% -14.0% -16.9% -15.4% -14.7% 65-69 -6.3% -10.7% -13.3% -15.7% -13.9% -12.8% 70-74 -11.3% -13.2% -14.2% -12.2% -11.8% 19 UNESPA Longevty Rsk Investgaton, Towers Perrn, 21 January 2009. 20 Ths assumton was verfed n the Towers Perrn aer. 21 Whole lfe 40/49

Age band Coverage duraton 5 10 15 20 25 30 WL 21 75-79 -13.2% -13.7% -11.3% -10.7% 80-84 -13.0% -9.8% -9.5% 85-89 -8.8% -8.7% 90-94 -8.8% Conclusons B.6. B.7. B.8. The dfferences between shocks for dfferent duratons are small and are not monotone so CEIOPS rejected the roosal to dfferentate shock for duraton of the contract. The dfferences between shocks for dfferent ages of nsured erson are hgher than for duratons. However they are not monotone for short term contracts. CEIOPS rejected the roosal to dfferentate shock for age at the nceton manly due to the smlcty of calculatons. The longevty rsk concerns manly ensoners who receve annutes. Dfferentatng shock would ncrease the comlexty of calculatons whle the accuracy of results ncreases slghtly because the number of nsured erson for ure endowment s relatvely small comared to number of ensoners. CEIOPS leaves the longevty stress unchanged because hstorc mrovements n mortalty rates observed n many countres are sometmes hgher than 25% and, accordng to QIS4 reort, the medan stress n nternal models equals 25%, wth an nterquartle range of 19% to 25%. 41/49

Annex C Analyss of annual lase rates n the Polsh lfe nsurance market Rsk descrton C.1. C.2. C.3. C.4. Accordng to the Artcle 105 (3) (f) of the Level 1 text, the lase rsk s defned as the rsk of loss, or of adverse change n the value of nsurance labltes, resultng from changes n the level or volatlty of the rates of olcy lases, termnatons, renewals and surrenders. Accordng to the QIS4 Techncal Secfcatons (ar. TS.XI.E.1), lase rsk relates to the loss, or adverse change n the value of nsurance labltes, resultng from changes n the level or volatlty of the rates of olcy lases, termnatons, changes to ad-u status (cessaton of remum ayment) and surrenders. In the Draft CEIOPS Advce for Level 2 Imlementng Measures on Solvency II: Treatment of lase rsk n the SCR standard formula, CEIOPS advces to take comrehensve aroach n relaton to the olcyholder otons that the lase sub-module covers. Ideally, the module should take account of all legal or contractual olcyholder otons whch can sgnfcantly change the value of the future cash-flows. Ths ncludes otons to fully or artly termnate, decrease, restrct or susend the nsurance cover as well as otons whch allow the full or artal establshment, renewal, ncrease, extenson or resumton of nsurance cover. However due to the lack of hstorc data on the use of each olcyholder oton, the followng calbraton covers only the ure olcy lases for whch data are avalable. Data used n the analyss C.5. C.6. The analyss s based on the rates of olcy lases n Polsh lfe nsurance undertakngs from 2004 to 2007. The number and rates of olcy lases for each roduct of lfe nsurance undertakngs are ncluded n the statement of the state of nsurance ortfolo, whch the actuary has to draw u annually and submt t to the suervsory authorty accordng to the Act on nsurance actvty. The statement of the state of nsurance ortfolo n lfe nsurance undertakngs for the artcular reortng year contans searately for each roduct the followng nformaton: roduct characterstcs: - tye of olcy: man, sulementary; - artcaton clauses: wth roft, wthout roft, unt-lnked; - tye of olcy: ndvdual, grou; - duraton of olcy: whole lfe, term; - classes of nsurance: 1, 2, 3, 4, 5 (accordng to Polsh law); number of olces n force; number of nsured eole; 42/49

C.7. C.8. C.9. number and rates of olcy lases n reortng year R from olces wrtten (sgned): - n reortng year R-+1 (to be called further as lase rate ), = 1, 2, 3, 4, 5 (fve rates); - at least 5 years before reortng year R (lase rate 5+), >5. The above-mentoned nformaton was sometmes not comlete because of lack of electronc verson of statements for some reortng years, wthdrawal of some roducts or ntroducton of new roducts n recent years. The lase rates were sometmes not reorted, the value equaled to 0 or was hgher than 1. Therefore only data meetng all the followng condtons were chosen for further analyss: data on each roduct were reorted n statements for three consecutve years, for each reortng year, for at least one, lase rate was reorted and was ostve, all lase rates were not hgher than 1, number of nsured eole n last reortng year equaled at least 100. Let x,n-r denote lase rate, =1,2,3,4,5,5+, for roduct n reortng year n-r, where n s the last reortng year and r=0,1,2,3. For each {1, 2, 3, 4, 5, 5+} Let P denote the set of those roducts, for whch at least three of the followng lase rate values x,n, x,n-1, x,n-2, ( 0; 1 >. x,n-3 C.10. For each lase rate (where {1, 2, 3, 4, 5, 5+}) and each roduct P let: k = 3 r = 0 n x, n r, where, n r 1 n s the number of lase rates x (0; >. C.11. For each {1, 2, 3, 4, 5, 5+} the standardzed lase rate equal y, n r = x, n r k,, r = 0,1,2,3, P C.12. The urose of calbraton s to analyze the volatlty of lase rates. The tme seres are too short to analyze the volatlty for each roduct. Therefore the calbraton s carred out on anel data. Snce for gven the samle mean of rates x,n, x,n-1, x,n-2, x,n-3 dffers among roducts, the standardzaton was necessary to remove between-samles varablty (.e. varablty resultng from the dfferences among roducts) from total varablty. The standardzaton rovdes the same mean of rates y,n, y,n-1, y,n-2, y,n-3 for lase rates wthn roduct. C.13. The total varablty of lase rates, =1,2,3,4,5,5+ s comosed of two varabltes: 43/49

44/49 2 3 0, 2 2 3 0, } 1,2,3,4,5,5 { ) ( ) ( ) ( = = + + = P r r n P P r r n x x x x x x where., 1, 1 3 0, 3 0, = = = = = P P r r n r r n n n x n x x n x The art of the total varablty whch equal P x x 2 ) ( results from the dfferent samle means of lase rates among roducts. After standardzaton, for each the mean from the whole samle, 1 3 0, = = P r r n y n y and the samle means for each roduct = = 3 0, 1 r r n y n y equal 1. Hence the total varablty of lase rate equals 2 3 0, 2 3 0, } 1,2,3,4,5,5 { ) ( ) ( = = + = P r r n P r r n y y y y. Moreover the standardzaton does not change the value of varaton coeffcent for gven roducts P y y Sd x k x k Sd x x Sd ) ( ) ( ) ( } 1,2,3,4,5,5 { = = +. C.14. To sum u, the shocks for lase rate, =1,2,3,4,5,5+ are calbrated on standardzed lase rates and the results of calbraton are the relatve changes of lase rates comared to average level of lase rate from last r years (n QIS4 the shocks refer to assumed future rates of lasaton). C.15. For each {1, 2, 3, 4, 5, 5+}, standardzed values of lase rate made the data samle to determne shocks. Moreover, for each {1, 2, 3, 4, 5, 5+} subsamles contanng lase rates for roducts wth artcular roduct characterstcs were formed. C.16. The extreme values and outlers for all standardzed lase rates wthn samle (ndvdually for the whole samle and ndvdually for each subsamle) were dentfed by the rogramme Statstca and were removed from further analyzes. Methodology assumtons C.17. On the bass of standardzed lase rates, =1,2,3,4,5,5+, the emrcal dstrbuton functons were derved, for the whole samle and for each subsamle.

C.18. The downward and uward shocks have been determned as and VaR 0.995 y y lase rate, where y = 1. VaR 0.005 y y resectvely of the emrcal dstrbuton functon for Table 1: The values of downward and uward lase shocks. Samle Tye of olcy Partcaton clauses Duraton Tye of olcy Lase rate All Man Su UL Wth Wthout Term Whole Indvd Grou Downward shock 1-87.3% -97.1% -95.0% -81.4% -76.1% -98.0% -97.8% -77.0% -94.6% -96.4% 2-86.2% -75.8% -89.8% -87.9% -73.2% -88.9% -75.6% -59.1% -74.3% -95.1% 3-79.2% -83.9% -75.7% -83.7% -62.3% -84.2% -72.7% -91.8% -71.9% -94.8% 4-69.1% -80.4% -56.0% -80.2% -66.5% -63.8% -82.2% -77.7% -61.1% -94.3% 5-81.9% -82.6% -77.1% -89.6% -51.0% -82.1% -82.8% -83.2% -70.3% -84.1% 5+ -68.5% -66.0% -67.1% -58.0% -65.8% -68.3% -65.6% -55.9% -51.0% -96.2% 1 103.6% 108.2% 97.2% 118.6% 75.0% 103.8% 106.0% 117.2% 99.9% 106.2% Uward shock 2 83.8% 74.6% 90.7% 81.6% 73.4% 90.3% 76.2% 65.2% 75.5% 98.9% 3 74.4% 76.1% 68.2% 81.8% 39.1% 74.4% 60.7% 81.7% 66.7% 84.9% 4 64.9% 63.0% 64.7% 64.7% 41.5% 65.1% 57.0% 62.8% 56.2% 84.2% 5 74.3% 75.2% 71.1% 75.9% 37.5% 74.3% 74.5% 78.9% 62.8% 104.8% 5+ 67.1% 69.9% 66.6% 45.4% 69.5% 63.0% 62.4% 57.3% 50.8% 113.7% C.19. The above downward and uward shocks should be nterreted as relatve changes of future lase rates for each roduct comared to average value of lase rates or comared to the assumed rates of lasaton, n all future years for olces where the surrender stran s exected to be negatve or ostve resectvely. 45/49

Annex D Imact assessment on lfe underwrtng rsk In ts Call for Advce of 1 Arl 2009, the Commsson has asked CEIOPS to contrbute to the Commsson s mact assessment of the Level 2 mlementng measures. 22 To ths end, a lst of ssues has been set u by the Commsson and CEIOPS, dentfyng the Level 2 mlementng measures that should be accomaned by an mact assessment. The objectves of the ssues have been selected among the lst of objectves used by the Commsson n ts Level 1 mact assessment. 23 On 12 June 2009, the Commsson has ssued an udated lst of olcy ssues and otons, to whch reference s beng made. 24 Ths mact assessment covers ssue 12 (sub-ssue B) of the lst of olcy ssues and otons. Two summary tables accomany the mact assessment, ublshed n a searate excel document. 1. Descrton of the olcy ssue D.1. The lfe underwrtng rsk module reflects the rsk arsng from the underwrtng of lfe nsurance contracts, n relaton to the erls covered and the rocesses used n the conduct of busness. It s calculated as a combnaton of the catal requrements for (at least) the followng submodules: mortalty rsk; longevty rsk; dsablty morbdty rsk; lfe exense rsk; revson rsk; lase rsk; and lfe catastrohe rsk. D.2. The ssue concerns the calculaton method to be adoted n Level 2 mlementng measures for the lfe underwrtng rsk (other than catastrohe rsk) n the SCR standard formula D.3. The desgn of the standard formula SCR shall am to be as rsk senstve as ossble wthout becomng overly comlex, achevng harmonzaton across Member States and ncentvzng mroved rsk management. D.4. The choce of methodologes avalable under the standard formula lays a fundamental role n achevng such objectve. D.5. In the otons below, when reference s made to "lfe nsurance", health nsurance conducted on a smlar bass to lfe nsurance s assumed to be also ncluded; smlarly, when reference s made to "non-lfe nsurance", health nsurance conducted on a smlar bass to non-lfe nsurance s assumed to be also ncluded. 22 htt://www.ceos.eu/meda/fles/requestsforadvce/ec-arl-09-cfa/ec-call-for-advce-solvency-ii-level- 2.df 23 htt://ec.euroa.eu/nternal_market/nsurance/docs/solvency/mactassess/fnal-reort_en.df 24 htt://www.ceos.eu/meda/fles/requestsforadvce/ec-june-09-cfa/udated-lst-of-olcy-ssues-andotons-for-ia.df. 46/49

2. Detaled descrton of olcy otons and assessment of the relatve macts on the dfferent affected artes D.6. Oton 1: Smulaton of the mact of a re-defned shock on the fnancal oston of the (re)nsurance undertakng (.e. Scenaro based aroach). D.7. A scenaro-based modelng aroach to lfe underwrtng rsk would requre the defnton of a set of scenaros that adequately descrbe any adverse develoment of the underwrtng result of the nsurers ortfolo. In general, catal requrements derved va a scenaro based aroach for lfe underwrtng rsk show a hgher rsk senstvty and would allow for a better algnment wth the calbraton standards under Solvency II comared to factor-based calculatons. D.8. Oton 2: Defnton of a closed formula calbrated to a VaR at the 99.5% confdence level over a one-year erod (desgn and calbraton of the closed formula to be determned) (.e. Factor based aroach). D.9. The concluson of the QIS2 exercse was that the catal requrement derved through a factor-based aroach was too low. QIS4 results also showed that ths aroach gves nsuffcent recognton to the rsk characterstcs of the undertakngs ortfolo. D.10. Gven the reduced comlexty of oton 2 comared to oton 1, a harmonzed alcaton of the method s more lkely to occur. Imact on ndustry, olcyholders and benefcares and suervsory authortes Costs and benefts Industry D.11. The scenaro based calculatons to be erformed are relatvely comlex for a substantal number of undertakngs (mostly for undertakngs of a lesser scale and wth actvtes of a lower comlexty). Ths would however not be a sgnfcant drawback as the rncle of roortonalty ncluded n the Level 1 text would allow ncluson of factor based smlfcatons for smaller undertakngs where the nature of the rsk s less comlex. 47/49

D.12. Due to ts lmted rsk senstveness, the factor-based method would robably result n a hgher catal requrement whch wll ush more sohstcated undertakngs towards the develoment of nternal models. Polcyholders and benefcares D.13. A more rsk senstve aroach would be the referred oton, as ths would am to cature rsks arorately and would make sure frms are adequately catalzed, rovdng addtonal securty to olcyholders. D.14. However for smaller - medum undertakngs ths method may be dsroortonate comared to the nature, scale and comlexty of ther rsks, resultng n ncreased costs and eventually leadng to an ncrease n exenses that would ultmately be assed on to olcyholders. Suervsory authortes D.15. The scenaro based aroach wll generate a substantal addtonal workload for some suervsory authortes (and may necesstate hrng secalzed and thus exensve staff). D.16. The comlexty of the aroach may have as an ncdence that the lmted understandng by undertakngs leads to dvergences n the alcaton of the methodology, n turn leadng to an unlevel layng feld between undertakngs n the ntal hases of the alcaton. Ths rsk s materal as the exertse of the suervsor also has to grow over tme so that at that ont n tme there s lttle correctve acton to be exected from the suervsor. 3. Relevant objectves D.17. The determnaton of the method for the calculaton of the lfe underwrtng rsk falls under the scoe of the followng oeratonal objectves: - Introduce rsk senstve harmonzed solvency standards, - Introduce roortonate requrements for small undertakngs - Harmonze suervsory owers, methods and tools. 48/49

4. Comarson between the dfferent otons based on the effcency and effectveness n reachng the relevant oeratonal objectves D.18. The comarson and rankng of the olcy otons s based on the effectveness and effcency of each oton n reachng the relevant objectves. Effectveness s defned as the extent to whch otons acheve the objectves of the roosal. Effcency s defned as the extent to whch the objectves can be acheved at the lowest cost (cost-effectveness). D.19. The QIS4 conclusons on the sutablty of the methodology for the calculaton of the lfe underwrtng rsk module confrms the very broad suort for the aroach under that exercse and reterates earler conclusons on the subject. D.20. The factor-based aroach does not meet the objectve of rsk senstvty. It may however be the referred methodology for less comlex undertakngs gven the comlexty of the scenaro based aroach. D.21. The scenaro-based aroach would be the referred aroach because of ts rsk senstvty. The refnement of the methodology n the Level 2 mlementng measures should ensure effcency of the aroach and the necessary harmonzaton thus ensurng that all objectves are met wth maxmum effcency. D.22. The comlexty of ths method for a sgnfcant number of undertakngs can be overcome through the ossblty of usng smlfcatons for some sub-modules. D.23. As to the objectve of harmonzed suervsory methods and tools, all aroaches dentfed am at achevng harmonzaton and ths goal could be reached n a nearly dentcal fashon under all otons. However, under the scenaro-based aroach due consderaton should be gven to the comlexty of the alcaton based aroach that may lead to a dvergent alcaton n the ntal hases of the alcaton leadng to an unlevel layng feld. D.24. In concluson, takng nto account the otental cost and benefts for olcyholders and benefcares, nsurance and rensurance undertakngs and suervsory authortes, the effectveness and effcency level to meet the relevant objectves, and ts sustanablty and comarablty levels, CEIOPS recommends Oton 1 n ts advce. 49/49