The World Bank Group
1st Contractual Savings Conference
The EU Solvency Margin
for Life Insurance
Michael Thom
Washington, 2 May 2002
Slide 1
Presentation Outline
• The Europe Union & Insurance
• The European Commission and the
basic EU Prudential Framework
• The EU Solvency Margin Regime
• Solvency I
• Solvency II
• Conclusions
Slide 2
The Europe Union & Insurance
Slide 3
Slide 4
EE
LV
LT
PL
CZ
SK
HU
SL
RO
BG
Slide 5
CYP
in millions (2000)
378
293
126
EUR 15
USA
JAPAN
Slide 6
x 1000 ha
937,260
323,620
37,780
EUR 15
USA
JAPAN
Slide 7
INSURANCE PREMIUM (mUSD 1999)
500000
450000
400000
350000
300000
250000
200000
150000
100000
50000
0
EU
USA
LIFE
JAPAN
ROW
NON-LIFE
Slide 8
EU INSURANCE PREMIUM / GDP
9
8
7
6
5
4
3
2
1
0
92
93
94
95
96
97
98
99
Slide 9
EU INSURANCE INVESTMENTS / GDP
60
50
40
30
20
10
0
92
93
94
95
96
97
98
99
Slide 10
The European Commission and the
basic EU Prudential Framework
Slide 11
20 Members
Right of
Initiative
Executive
Power
Guardian of
the Treaties
Slide 12
European Commission
Key objective :
• Creation of a single market
Classic reasons:
• Economic efficiency
• Increased choice and quality,
• lower prices
Slide 13
Basic Prudential Framework
Three Generation of Life & Non-Life Directives:
•
•
•
•
the single licence
exclusive home country control for prudential matters
freedom of establishment & provision of services
minimum harmonisation and mutual recognition of supervisory /
prudential standards
Slide 14
Basic Prudential Framework
• no economic needs test
• no prior approval of premia or premia
changes
• no prior approval of policy conditions
CONCLUDE:
most open liberal system in world
Slide 15
Basic Prudential Framework
–
–
–
Prudential supervision: sole responsibility of the
home Member State, who shall require
sound administrative and accounting procedures
and
adequate internal control mechanisms of the
company, and
Slide 16
Basic Prudential Framework
Respect of common EU financial rules covering:
fit & proper managers
(premiums)
technical provisions
investment rules
solvency margin
Slide 17
The EU Solvency Margin Regime
Slide 18
Rule of Law / Fit & proper managers
Liabilities
Assets
Solvency
Margin
Technical
Provisions
Investment
Rules
Adequate
premiums
Slide 19
Fit & Proper Managers
• Fitness :
formal qualifications,
experience
• Propriety:
financial position, absence of
criminal record, questionable
business practices
• Very important
• Managers can react long before supervisors
Slide 20
Technical Provisions
• Meet all liabilities at all times
(as far as can be reasonably foreseen)
• prudent
• more developed for life
Slide 21
Technical Provisions- Life
• Must establish sufficient technical
provisions
• prospective actuarial basis
• prudent valuation (claims and expenses)
• all options
- (guaranteed surrender values)
• reference rate of interest
- (60% state bond; portfolio rate)
Slide 22
Investment Rules (ALM)
• Assets covering technical provisions take
account of :
–
–
–
type of business
need to secure safety, yield, marketability
requirement to be diversified and adequately
spread
Slide 23
Investment Rules (ALM)
Assets covering technical provisions:
• list of admissible assets
(marketable securities, land, buildings, tax
recoveries, salvage, rent, etc.)
• prudently valued
• derivatives:
–
–
only to reduce risk / manage portfolio
in relation to underlying assets
Slide 24
Investment Rules (ALM)
Assets covering technical provisions:
• max 10% in one piece of land or building
• max 5% in single bond, share, debt, etc.
• max 5% in unsecured loans,
–
1% single unsecured loan
• max 3% in cash
• max 10% in unregulated market securities
Slide 25
Investment Rules (ALM)
Assets covering technical provisions:
• no obligation to invest in particular assets
(but Member States may limit)
• EU localisation
(EU risks matched by EU assets)
• Currency matching
max 20% non-currency congruence
(Euro always congruent)
Slide 26
The EU Solvency Margin
Slide 27
Solvency Margin:
Basic definition:
“ assets of the undertaking free of any foreseeable
liabilities less any intangible items”
Slide 28
Solvency Margin: Eligible Items
•
•
•
•
•
Paid-up share capital (contributions)
50% of unpaid capital ( after 25% paid)
Free reserves
Profits carried forward
Cum. pref. Shares / subordinated debt (max 50%)
– less
• Intangibles
Slide 29
Solvency Margin: Eligible Items
• Hidden reserves (unrealised gains)
plus
Life:
• max 50% future profits, max 10 years
Slide 30
Solvency Margin Requirement- LIFE
Technical Provisions (TP)
Investment risk
(4% of 2000)
No inv. risk
(1% of 2000)
& >5 yr. expense guar.
-
80
20
------100
reinsurance reduction
Total
x85%
85
Slide 31
Solvency Margin Requirement- LIFE
Capital at risk
Sum assured
Technical provisions
capital at risk
(x0.003)
reinsurance reduction
solvency margin requirement
10 000
4 000
6 000
18
x50 %
9
Slide 32
Solvency Margin Requirement- LIFE
• Technical provisions
• Capital at risk
• Total
85
9
94
Slide 33
The guarantee fund
Equals a third of solvency margin required
but subject to a minimum guarantee fund:
class
9 and 17
1-8, 16, 18
10-13, 15
14
Life
mEURO
0.2
mEuro
2.0
0.3
0.4
1.4
0.8
2.0
3.0
3.0
3.0
Slide 34
What happens when things go wrong ?
• Staged approach
• If actual solvency margin < required solvency margin
• then company must submit for approval a plan for the
restoration of a sound financial position
Slide 35
What happens when things go wrong ?
• If actual solvency margin < guarantee fund,
• then short-term finance scheme for approval
• supervisor may restrict or prohibit free disposal of assets
• supervisor may take all measures necessary to protect insured
(idem if technical provisions not covered)
• must inform other Member States
• who may take the same measures
Slide 36
What happens when things go wrong ?
• if technical provisions not covered
• supervisor may also take all measures necessary to
protect insured
Slide 37
SOLVENCY I
Slide 38
• EU solvency margin system is
•
•
•
•
•
Simple
Robust
Easy to understand and use
Inexpensive to administer
Has worked well in practice
Slide 39
97 Commission Report
• Present scheme has proved satisfactory
• Certain weaknesses in specific cases
• Main alternatives not demonstrably
superior
• Avoid unnecessary cost to industry
Slide 40
SOLVENCY I : Main themes
•
•
•
•
•
•
Level of harmonisation
Minimum guarantee fund
Special supervisory powers
Reinsurance
“Class enhancement approach”
Miscellaneous
Slide 41
1.
Level of harmonisation
• Minimum or full ?
–
Not clear
• Now clearly minimum harmonisation
–
–
–
in practice
mirrors banks, investment firms
subsidiarity principle
Slide 42
2.
Minimum guarantee fund
• Unchanged since 1973 (non-life) 1979 (life)
• Impact of inflation on claims and expenses
class
9 and 17
1-8, 16, 18
10-13, 15
14
Life
mEURO
0.2
mEuro
.0
0.3
0.4
1.4
0.8
2.0
2.0
3. 2 0
3.0
3.0
3.0
Slide 43
3. Special supervisory powers
• When policyholders rights are threatened,
supervisors may take early intervention
• Supervisors can:
–
–
–
require financial recovery plan
require higher solvency margin
revalue downwards all solvency margin items
Slide 44
4. Reinsurance
• Max. reduction of 50% retained
• Calculated over last 3 years
• Decrease reinsurance reduction if:
–
–
nature or quality of reinsurance programme
changed
no significant risk transfer
Slide 45
5.
Class enhancement approach
• Problem for long term, long tail risks
• Third index not a solution
–
indiscriminate, perverse
• Keep simplicity of current method
• but increase current solvency margin for
“risky” classes of business.
Slide 46
6.
Miscellaneous
Future profits :
• Currently
• Propose“
max. 50% for max. 10 years
50% “
“
6
“
but
– actuarial report
– no double counting with hidden reserves
• But…….only up to 2009
Slide 47
6.
Miscellaneous
Unit-linked business- Life
• where no investment risk
• where expenses not fixed for more than 5
years
• Required solvency margin = 25% of
relevant overheads
Slide 48
• Strengthens solvency margin requirement
• Important- more competition in future
–
–
(tariff liberalisation, new distribution channels,
euro, further consolidation and integration,
“shareholder value”)
(reduced investment profits)
Slide 49
Implementation Timetable
•
•
•
•
14 Feb 2001
Adoption by Council & EP
20 March 2002
Publication in OJ
20 Sept 2003 In force
2002-2007
Transitional period
Slide 50
SOLVENCY II
Slide 51
Solvency II
Solvency I good, but……….
•
•
•
•
Size effect (law of large numbers) ?
Volatility of different risks ?
Diversification ?
Quality of internal controls & risk management ?
Slide 52
Solvency II
Solvency II
Consider overall financial position of insurer
examining ……….
Slide 53
Solvency II
•
•
•
•
•
•
•
•
Technical provisions
Assets
Asset liability management
reinsurance
Solvency margin methodology
Accounting and actuarial
Internal risk models
Role for rating agencies ?
Slide 54
Solvency II
OBJECTIVES :
• Protect policyholders
• Comparability, transparency and coherency
(creating level playing field)
• Solvency margin better matched to true risks
• Avoid undue complexity
Slide 55
Solvency II
OBJECTIVES (cont.) :
• Reflect market developments (ART, derivatives, ALM
• Establish principles, not excessively prescriptive
• Where possible, common accounting policies
• Avoid unnecessary capital costs to industry
Slide 56
Solvency II : WORK ORGANISATION
• Close cooperation with Member States
• Solvency subcommittee of Insurance Committee
- Two working groups (non-life & life)
• EU Conference of Insurance Supervisors
–
Working group on insolvencies and “near misses”
• International Co-operation, IAIS
Slide 57
Solvency II: WORK ORGANISATION
• Commissioned external consultants report on
“Methodologies to assess the overall financial position
of an insurance undertaking from the perspective of
prudential supervision”
• Regular input from insurance business, actuaries and
other interested parties
• Visits to major EU insurers and reinsurers
(Internal Models)
Slide 58
Solvency II
TWO STEP APPROACH
• First phase: preparatory discussions leading up to a
decision on the general layout of a future EU solvency
system.
• Second phase: further work to elaborate detailed
solutions, draft regulatory texts and field-testing
Slide 59
Solvency II
No decisions yet ; lots of QUESTIONS:
• What risks should be taken into account?
• What rules should apply to technical provisions?
• How to include asset risk more explicitly?
• What about operational risk and other business
risks? Reinsurance risk?
• What risks can and should be quantified?
• What other risks are better dealt with in a more
qualitative way “second pillar”?
Slide 60
CONCLUSIONS
• Existing solvency margin :
simple, robust, worked well, but
• Solvency I :
significant package of improvements
• Solvency II :
ambitious, long term project
reviews overall financial position
Slide 61
Michael THOM,
Principal Administrator and
Secretary of the EU Insurance Committee
Insurance, Financial Institutions,
Internal Market DG
European Commission
200 rue de la Loi, B-1049 Brussels, Belgium (C107 1/62)

+32-2-296.6068
Fax
+32-2-299.3075
E-mail
Michael.Thom@cec.eu.int
Internal Market DG site:
http://europa.eu.int/comm/dgs/internal_market/index_en.htm
Slide 62
• The END
Slide 63
EXTRA:
INSURANCE GROUPS
Slide 64
Introduction
• Increasing number of insurance groups
–
–
–
Mergers and Acquisitions
Globalisation
Financial Services Integration
Supervisory question
• If each part is OK, is the group OK?
Slide 65
Some problems
• Supervision at level of individual insurance
company
( ‘solo’ level)
Apparently satisfactory situation for:
• solvency margin (capital adequacy)
• assets and liabilities
• but……………..
Slide 66
Insurer A
Liability
40 cap
1000 TP
1040
Assets
1000
40 (inv. B)
1040
actual solvency margin = 40 = required solvency margin
Slide 67
Insurer B
Liability
40 cap
1000 TP
1040
Assets
1040
1040
actual solvency margin = 40 = required solvency margin
Slide 68
double gearing problem
(B is a 100% subsidiary of A)
InsurerA
A
Insurer
Liability
Assets
40 cap
1000 TP
1040
Insurer B
Assets
Liability
1000
40 cap
40 (inv B) 1000 TP
1040
1040
1040
1040
actual solvency margin = 40 = required solvency margin
Slide 69
double gearing problem
(B is a 100% subsidiary of A)
Consolidated A & B
Liability
40 cap
2000 TP
2040
Assets
2040
2040
actual solvency margin = 40
required solvency margin =80 !!!
Slide 70
Intra-Group Transactions
Similarly can circumvent
asset or liability rules for insurer A
by ‘hiding’ in insurer B
through intra-group transactions
e.g. loans or guarantees
Slide 71