Solvency II
and the Swiss Solvency Test
Contents

Swiss Solvency Test

Industry Engagement -Test Runs
2
Swiss Solvency Test
Swiss Solvency Test

Switzerland is not member of the European Union, but
Swiss companies have pivotal interest in EU regulation

Compatibility to EU is a main objective of SST

Swiss Federal Office of Private Insurance designed,
tested and partially implemented the new solvency
system between 2002 and 2006

New Insurance Supervisory Law effective since 2006

Full implementation of SST beginning 2011
4
Old Insurance Supervision

Rule based

Product and Tariff Approval

Restrictions on products, investments and pricing

No consideration of asset risks
5
Old Insurance Supervision - Problems

Overexposure to risky assets

Underpriced long term guarantees

Accounting and regulatory arbitrage

Compliance culture

Abrogation of responsibility to the regulator
6
New Insurance Supervision Act of 1.1.2006

No restrictions on products (except for some mandatory
life and health products)

Less restrictions on investments

Corporate governance and risk management
requirements

Appointed Actuary for all insurers and reinsurers
7
New Insurance Supervision Act of 1.1.2006

Supervision of groups and conglomerates

Consistent requirements for insurers and reinsurers

Responsibility with senior management

Principle based
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The SST Principles
Output – Methodology – Transparency - Responsibility
1. All assets and liabilities are valued
market consistently
2. Risks considered are market, credit
and insurance risks
3. Risk-bearing capital is defined as the
difference of the market consistent
value of assets less the market
consistent value of liabilities, plus the
market value margin
4. Target capital is defined as the sum of
the Expected Shortfall of change of
risk-bearing capital within one year at
the 99% confidence level plus the
market value margin
5. The market value margin is
approximated by the cost of the
present value of future required
regulatory capital for the run-off of
the portfolio of assets and liabilities
6. Under the SST, an insurer’s capital
adequacy is defined if its target
capital is less than its risk bearing
capital
7. The scope of the SST is legal entity
and group / conglomerate level
domiciled in Switzerland
8.
Scenarios defined by the regulator
as well as company specific
scenarios have to be evaluated
and, if relevant, aggregated within
the target capital calculation
9.
All relevant probabilistic states
have to be modeled
probabilistically
10.
Partial and full internal models can
and should be used. If the SST
standard model is not applicable,
then a partial or full internal model
has to be used
11.
The internal model has to be
integrated into the core processes
within the company
12.
SST Report to supervisor such that
a knowledgeable 3rd party can
understand the results
13.
Public disclosure of methodology
of internal model such that a
knowledgeable 3rd party can get a
reasonably good impression on
methodology and design decisions
14.
Senior Management is responsible
for the adherence to principles
9
Timetables
EU
Switzerland
Political Decision
2002
2002
Project Start
2003
2003
Consulting Phase
2003 to 2009
2003 to 2005
Quantitative Impact Studies /
Field Tests
2005 to 2009
2004 to 2007
New Legislation
2007 to 2011
2006
Mandatory Reporting
2012
2008
New Intervention Regime
2012
2011
10
Some Differences SST – Solvency II

99% TVar vs. 99.5% Var confidence level

Cost of Capital approach for Market Value Margin
–

EU has not yet decided between i) 75th percentile and ii) Cost of
Capital approach
Minimum Capital Requirement 60% of Solvency Capital
Requirement
–
EU has not yet decided between i) percentage of SCR and ii)
separate calculation for MCR, i.e. 90% confidence level

Operational Risk taken into account, but not part of Pillar I, as
not sufficiently quantifiable

No restrictions on eligibility of capital – no tiers
11
Cost of Capital Approach

SCR absorbs risks with 1 year time horizon

At the end of year 1, portfolio is assumed to be taken
over by another company

New company provides regulatory capital to absorb runoff risk

Market Value Margin is the NPV of the future cost of
capital at risk free rate + 6%
12
Internal Models

If standard model not applicable, internal models mandatory
–
reinsurance, groups, entities with foreign branches
– estimated 80 entities will have to develop internal models

Internal models encouraged, as they demonstrate high risk
management skills and provide relevant company specific
information

High technical standards: stochastic modelling required.
Building and validating internal models is resource intensive.

Consistency: same model should be used for all external
reporting (regulator, rating agencies) and internal steering
purposes
13
Groups

Incentive to simplify complex group structures

SST required both on entity level and group level

Detailed internal model for groups

Diversification benefit on group level

Explicit modeling of Capital and Risk Transfer Instruments
–
–
–
–
–
internal reinsurance
loans
participations
guarantees
capital mobility
14
Small Companies

Increased consolidation pressure

Complexity of Solvency II is a challenge for small
entities:
– limited availability of resources and data
– low participation in test runs indicates lack of awareness
– loss mitigation relatively expensive
– standard model leads to high capital requirements,
building more favourable internal models not viable
15
Risk Management & Risk Mitigation

Risk Management will become key competence
– Data quality
– Capital adjusted pricing and product structuring
– Modelling capabilities

Demand for Risk Mitigation will increase
– Hedging financial risk for life insurers
– Reinsuring or securitizing catastrophical risk for P&C
insurers
16
Industry Engagement -Test Runs
Quantitative Impact Studies

2005: QIS 1
–
–
–
–

2006: QIS 2
–
–
–

tested methods for calculating provisions, asset values, SCR and MCR
gathered information on practicability, data issues and resource
requirements
measured changes of overall level of solvency ratio
2007: QIS 3
–
–
–
–

compared reserves under Solvency I and Solvency II
measured existing levels of prudence
tested Cost of Capital approach
increased awareness in the insurance industry
calibrates risk and correlation matrices
tests impact on groups
tests internal vs standard models
results to be published in fall 2007
2008: QIS 4 to back test draft directives
18
Quantitative Impact Study 2

514 companies (out of 4‘000) from 23 countries
participated
– 237 P&C, 161 Life, 81 Composite, 22 Health, 13
Reinsurance

Overall market share 65% for Life, 56% for P&C
– vary from 11% to 94% from country to country

Generally lower participation by small companies

Data quality inhomogeneous

Results published on a no name basis
19
QIS 2 – Impact on Solvency

Assets valuated higher

Liabilities valuated lower

> Resulting Available Capital higher

Required Capital much higher

> Solvency Ratios decrease in general

Most Companies still with Solvency Ratios > 100%
20
Swiss Field Tests

Facultative in 2004 and 2005 (before new legislation)

Mandatory for large companies in 2006 and 2007

46 (out of 150) entities participated in 2006, 29 of them
on a voluntary basis. >90% market share covered.

Mandatory reporting for all companies starting 2008

Intervention based on new regime starting 2011, i.e.
three year transition period
21
SST - Solvency Ratios

Solvency Ratios lower, but mostly still sufficient (similar
to QIS results)

Life: low correlation between old and new Solvency
Ratios (R2 = 12%)

P&C: no correlation between old and new Solvency
Ratios (R2 < 1%)

i.e. completely new situation for most companies
22
SST - Breakdown of Balance Sheets
Approximative Numbers
Life
Health
P&C
Reserves at Best
Estimate
90%
50%
90%
Solvency Capital
Required
8%
25%
7%
Market Value Margin
2%
0%
0%
Excess Capital
0%
25%
3%
Solvency Ratio
100%
200%
150%
23
SST - Breakdown of SCR & MVM
Approximative Numbers
Life
Health
P&C
Market Risk
70%
80%
30%
Credit Risk
5%
5%
10%
Insurance Risk
15%
25%
90%
Scenarios
10%
30%
0%
Diversification
(SCR reduction)
-20%
-20%
-25%
Expected Profit
(SCR reduction)
0%
-20%
-10%
Market Value Margin
20%
0%
5%
24
SST – Historic Scenarios - Life
Approximative Numbers
Solvency drops from
100% to...
Market Crash 2000/2001
< 60%
European Currency Crisis 1992
70%
Market Crash 1987
75%
LTCM 1998
75%
Real Estate Crash 1994
80%
25
Breakdown of Insurance Risk – P&C
Approximative Numbers
Normal Claims
45%
Large Claims
15%
Reserves
40%
Diversification
0%
26
Key findings

Life insurers sufficiently, P&C insurers well capitalized

Assets main risk for life insurers, balance sheets
vulnerable to historic economic scenarios

Insurance (underwriting including catastrophe) main risk
for P&C insurers, balance sheets resistant to scenarios

Market Value Margin (reserve risk beyond 1 year)
almost negligible for P&C insurers, more important for
life companies
27