Solvency II
A Work in Progress
CAS Meeting, Quebec
Alessa Quane
June 2008
Soundbites
“This is an ambitious proposal that will completely overhaul the way we ensure
the financial soundness of our insurers.” – Charlie McCreevy, European
Commissioner for Internal Market and Services
“We are setting a world-leading standard that requires insurers to focus on
managing all the risks they face and enables them to operate much more
efficiently. It’s good news for consumers, for the insurance industry and the
EU economy as a whole” - Charlie McCreevy, European Commissioner for Internal
Market and Services
“Solvency II is not just about capital. It is a change of behavior.” – Thomas
Steffan, Chairman of CEIOPS
“The purpose of Solvency II is not necessarily to strengthen the industry’s
capital base, but more to ensure that sufficient regulatory and internal risk
management controls are in place to enable management and regulators to
more fully understand and control the dynamics of the industry’s risk profile.”
– Simon Harris, Moody’s Team Managing Director for European Insurance.
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What is Solvency II?
Updated set of insurance regulations for Europe facilitating the
creation of a single market for insurance services in Europe while
protecting consumers at a consistent level across all member states
Will introduce economic risk-based solvency requirements across
all EU Member States
Total balance sheet approach versus only focusing on the liability
side as Solvency I does
Emphasizes that capital is not the only way to mitigate against
failures. Solvency II rules compel insurers specifically to focus on
and devote significant resources to the identification, measurement
and proactive management of risks.
Strengthen the role of the group supervisor
While Solvency II is a European initiative, many outside the EU are taking an interest
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in the development of the framework and its implementation.
Lamfalussy Process
What is it?
What does it include?
Who develops it?
Who decides?
Level 1
Solvency II Directive
Overall framework principles
European Commission
European Parliament & Council
Level 2
Implementing measures
Detailed implementation
measures
European Commission
European Commission with
consent of EIOPC & EP
Level 3
Supervisory standards
Guidelines for day to day
supervision
CEIOPS
CEIOPS
Level 4
Evaluation
Monitoring compliance and
enforcement
European Commission
European Commission
Source: CEA
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Solvency II Key Players
European Union Parliament
European Council of Ministers
European Union Commission
Committee of European Insurance and Occupational Pension
Supervisors (CEIOPS)
CEA (Comité Européen des Assurances)
Groupe Consultatif
Other stakeholders - CRO Forum, national regulators, individual firms
both within the EEA and outside
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Solvency II Timetable
2005
2007
2006
2008
Directive Development
Directive
Adoption
QIS 1
QIS 4
QIS 2
QIS 3
2009
2010
Framework
Directive
Published
2011
2012
Full
Implementation
Further QIS
* Initial discussions and drafting began prior to 2005.
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Solvency II Timetable
2008 is a crucial year in the timetable

Framework Directive defining the Level 1 principles for Solvency II
will pass through the EU Parliament

Level 2 detailed implementing measures will be developed by the
EU Commission

CEIOPS and other stakeholders will provide advice on the Level 2
measures

Individual firms will participate in QIS 4 and suggest wording for
the Level 2 measures
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Three Pillars of Solvency II
Pillar I
Pillar II
Pillar III
Surplus
Disclosure
Requirements
Surplus
Add-Ons
SCR
SCR
MCR
MCR
Assets
Assets
Risk Margin
Risk Margin
Liabilities
Liabilities
Firm Analysis
Supervisory Analysis
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Solvency Capital Requirement Standard Formula
SCR
Basic SCR
Non-Life Insurance
Market
Operational
Health Insurance
Credit
Life Insurance
Premium & Reserve
Foreign Exchange
Long Term
Mortality
Catastrophe
Spread
Short Term
Longevity
Interest Rate
Workers Compensation
Catastrophe
Concentration
Property
Revision
Equity
Lapse
Expense
Disability
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Financial Impact of New Regime
I.
Solvency capital requirements will increase substantially for most
European insurers, although the proposed regime does not
require extra capital in the European insurance market as a whole.
II.
No significant overall change in terms of the composition or size of
the balance sheet compared with Solvency I at a European level
III.
Technical provisions tend to decrease due to the implicit prudence
in the current regime thereby increasing available capital
IV.
98% of firms would find it unnecessary to raise additional capital to
meet the MCR
V.
16% of insurers would need to raise additional funds to cover the
SCR under QIS 3
VI.
QIS 3 results indicate that non-life insurers appear to be more
heavily impacted than life insurers
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Composition of Non-Life SCR
Source: CEIOPS’ Report on its Third Quantitative Impact Study for Solvency II
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SCR Comparison with Internal Models
I.
Internal models generally produce a higher charge for credit risk
than the SCR module
II.
For non-life insurance, internal models produce significantly lower
total SCRs than the standard formula, with an average reduction
of 25%
III.
No clear pattern as to whether internal models produce a lower or
higher operational risk charge than the standard formula
Internal Model
submissions in
QIS 3
Number of
Models
Life
Full
54
56
15
Full and
Partial
55
65
15
Non-Life Composite
Represents 13% of firms, by submission numbers
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Areas for Further Investigation
I.
Non-EU supervisors and group proposals
I.
Equivalence of regimes
II.
Level playing field for EU and non-EU groups
III.
Application of a consistent economic assessment of available
and required capital to all businesses, both EEA and non-EEA
II.
Technical Provisions
I.
More guidance on calculation of the risk margin
I.
II.
Is the 6% cost of capital still a placeholder?
Diversification between lines of business
II.
Debate around possible simplifications or proxies to make up for
a lack of data
III.
Recognition of future premium
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Areas for Further Work
III.
SCR
I.
Calibration of non-life underwriting risk
II.
Granularity of equity risk shocks
III.
Treatment of unrated entities with regard to counterparty default risk
IV.
Possible simplification of the concentration risk component and impact on
firms in smaller countries with fewer market options
V.
Inclusion of expected profits
VI.
Exclusion of free assets in the market risk module
VII.
Appropriate treatment of catastrophes
IV.
Structure and calibration of the MCR
I.
Ladder of intervention
II.
Consistent framework
I.
Compact Approach
II.
Modular Approach
III.
Linear Approach
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Areas for Further Work
VI.
Own Funds
I.
Guidance on classification of eligible elements
II.
Implications for hybrid instruments
III.
Clarification on valuation of participations (look-through vs market
value)
VII. Groups
I.
Non-comparable data has been supplied and clarification is
therefore needed in order to draw conclusions on these issues
I.
Scope of consolidation
II.
Group coverage
III.
Internal model results
IV.
Consideration of the rules to which cross sector and non-EEA
entities are subject as well as the extent to which surplus assets are
transferable
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Areas for Further Work
VIII. Internal Models
I.
Criteria for model approval
I.
II.
III.
Statistical quality
Use test
Documentation standards
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Implications for Firms
I.
Require more formal approach to governance demonstrating that
insurers are aware of the risks affecting their business and that they
have embedded this awareness in the daily running of the business.
II.
Cost of compliance is likely to be significant and will be a large
change for many jurisdictions.
III.
Possible consolidation within the insurance industry as small firms
may be disadvantaged by lack of technical resources, lack of
geographic and product diversification and more expensive capital
IV.
Move toward risk sensitive pricing as a result of more efficient capital
allocation. This will lead to greater segmentation and value driven
products.
V.
Increase demand for reinsurance, liability securitization and hedging
VI.
Further fuel the rating agencies shift in focus onto companies’ risk
management frameworks and desire for disclosure.
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Implications for Actuaries
I.
Require more complex analysis and systematic approaches
to risk management. This will increase the demand for
actuaries and risk management personnel.
II.
Need to more closely coordinate with finance, risk
management and other business functions.
III.
Better explanation of assumptions, sensitivities, limitations
and methods underlying the computations and results to
senior management who will be relying on this information
throughout the risk embedding process.
IV.
Increase in the development of advanced analytical tools and
systems capable of providing a more informed basis for
control and decision-making.
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