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Solvency II and Pension Funds

Instituto de seguros de Portugal25 Oct. 2007 | Lisbon

Source CEA

CEA and the European industry’s input to Solvency II

Essential Building Blocks of Solvency II

Key Aspects of CEA’s High-level Position on the Solvency II Directive

Key benefits for consumers

Areas of particular relevance for SMEs

Solvency II recognising the economic reality of groups

Solvency II and pension funds

Conclusions

3

Outline:

1

4

2

Source CEA

CEA’s Member Associations

Source CEA

33 national member associations:

27 EU Member States

+ 6 Non-EU Markets

Switzerland, Iceland, Norway, Turkey,Liechtenstein, Croatia

3 Observers

Russia Ukraine

AISAM

Brussels-based, founded in 1953

Active at European and International level

33 member bodies - national insurance associations

CEA represents all types of insurance and reinsurance undertakings

pan-European companies, monoliners, mutuals & SMEs

CEA represents 94% of total European insurance premiums

About CEA

A successful Solvency II project requires co-ordination of all stakeholders

Stakeholders in the drafting process of the Solvency II Directive

European Parliament

Councilof Ministers

EIOPC

CEIOPS

European Commission(DG internal market)

Insurance Industry stakeholders

CFO ForumCRO Forum

CEA

AISAM/ACMEICISA

Other stakeholders

National Insurance

Associations

Insurance Companies

Groupe Consultatif

CEA

CEA main contribution since the beginning of the Solvency II process

Communication and consensus-building

Answers and comments to Calls for Advice, various position papersElaboration of Total Balance Sheet ApproachPosition papers and working papersBriefing Notes

QISs and the European Standard Approach

Release of working documents on ESA (spreadsheet and guidance)Solid basis for dialogue and negotiation with all stakeholdersGuidance on QISs

Group Case StudiesEnsures a good understanding of EC proposal on Groups

CEA overall welcomes the Solvency II Directive Proposal

Ref. today’s presentation

CEIOPS’ Quantitative Impact Study IIConsideration of a risk based economic/total

balance sheet approachInclusion of Cost of Capital (incl. development

of methodology)Very close to European Standard Approach

Commission’s Impact AssessmentCEA approached by Commission to deliver

input for impact assessmentCEA’s answer: launch of European-wide survey

in view of delivering a common industry feedback

MAIN CONTRIBUTION

Source CEA

CEA and the European industry’s input to Solvency II

Essential Building Blocks of Solvency II

Key Aspects of CEA’s High-level Position on the Solvency II Directive

Key benefits for consumers

Areas of particular relevance for SMEs

Solvency II recognising the economic reality of groups

Solvency II and pension funds

Conclusions

2

3

Outline:

1

4

Why a new Solvency framework ?

Solvency regimes need to evolve to ensure appropriate consumer protection and efficient capital allocation

Solvency I disadvantages:Rules can conflict with good risk managementCapital is not adequately directed to risksA lack of harmonisation across the EU

Some member states use more sophisticated approachese.g. UK ICA, Danish traffic light system, etc

Europe is ready for a better and more appropriate risk based solvency regime

Objectives of Solvency II

The Industry shares the objectives set out for Solvency II

Deepen integration of the EU insurance market

Improve protection of policyholders and beneficiariesA major step forward from Solvency I supported by the new economic perspective

Improve international competitiveness of EU insurers

Promote better regulation

What is an economic risk based approach?

The industry believes that these objectives can only be achievedthrough a risk based economic approach

assets and liabilities at market-consistent values

full recognition of diversification and risk mitigation of all forms (reinsurance, securitization etc.)

aligning capital requirements with the underlying risks of an insurance company

developing a proportionate, risk-based approach to supervision with appropriate treatment both for small companies and large, cross border groups

maintaining strong, effective policyholder protection while achieving optimal capital allocation

11

From Solvency I to Solvency II:Towards a coherent economic approach

Future

Current situation

• Consistent view on solvency measures across all parties

• Discussions with supervisors and rating agencies focus on accuracy of internal model and quality of risk management

• Multiple ways of assessing solvency which are not always consistent and can even contradict each other

• Not aligned with best practice internal risk management

True risk profile

SCR* - Internal Models

SCR* - Standard Approach

Rating agency models

Current Solvency I rules

Range of solvency measures

Increasinglyaccurate

*Solvency Capital Requirements (SCR)

12

Align risk, capital and value

Eligible capitalTechnical provisionsCapital requirementsAsset Liability valuationetc

Internal controlRisk managementCorporate governanceStress testingContinuity testing

Current disclosure requirement

National GAAPNational regulatory reporting

Future disclosure requirements

IFRS Phase 2Private disclosure to the regulator

Market DisciplineSupervisory ReviewProcess

Measurement of Assets,Liabilities and Capital

Solvency II – 3 Pillar Approach

Solvency Capital Requirement (SCR)Target Capital that an entity should aim to meet under normal operating conditionsDropping below SCR does not necessarily require immediate supervisory intervention

Ladder of InterventionSolvency II should be designed to guarantee an appropriate ladder of intervention if the available capital falls below SCR

Minimum Capital Requirement (MCR)Reflects a level of capital below which ultimate supervisory action should be triggeredIs set in excess of technical provisions

Market Consistent Value of LiabilitiesIs sufficient to cover policyholder obligations

Internal Model

Standard Approach

Market -consistent Value of

Liabilities

(i.e. including MVM*)

Level of MCR

Level of SCR

Solvency II Framework Key Components

Ladder of intervention

*Market-value margin for unhedgeable risks

Source CEA

CEA and the European industry’s input to Solvency II

Essential Building Blocks of Solvency II

Key Aspects of CEA’s High-level Position on the Solvency II Directive

Key benefits for consumers

Areas of particular relevance for SMEs

Solvency II recognising the economic reality of groups

Solvency II and pension funds

Conclusions

2

3

Outline:

1

4

CEA welcomes the Solvency II Directive Proposal

The underlying economic approach is strongly supportedReplacing Solvency I regulation which is too simplistic and does not adequately allocate the capital to where the risks are.Eliminating regulatory arbitrage.

Strong support for the use of internal modelsEncourage companies to develop more sophisticated models to determine their capital requirements;These so-called internal and partial models are being approved by supervisors.

A solvency system that will evolve and continue to be appropriate in the future

The principles based approach, together with the underlying risk based economic methodology, means that the Solvency II regime will be able to adapt and evolve in the future as economic conditions change and new risks and products emerge. The CEA strongly supports the flexibility and adaptability inherent in the Framework Directive.

CEA welcomes the Solvency II Directive Proposal

Much increased harmonisation across the EU

ProportionalityThe CEA supports the implementing measures to be proportionate for:

the technical provisions; SCR; and supervisory powers.

CEA would welcome the opportunity to help develop such approaches, which are needed to help smaller companies avoid excessive Solvency II implementation costs.

A major step forward in the supervision of groupsRecognizing the economic reality of groups;CEA strongly supports the concept of a group supervisor who has primary responsibility for all key aspects of supervision.

SII Directive Proposal - Areas requiring further improvement

MCR and SCR calculation methods need to be aligned CEA: The MCR should be expressed as a percentage of the SCR

The treatment of own funds should be consistent with a policyholder view

Detailed calculation specifications should not be in the DirectiveReduces the flexibility of Solvency II to reflect emerging experiences and new methodologies.

SII Directive Proposal - Areas requiring further improvement

It is essential that supervisory powers are proportionate and harmonisedDetailed guidance needed to define the extent and circumstances under which new or harmonized powers would be expected to be exercised.

CEA is therefore concerned by:The wide ranging and open ended nature of the powers available to supervisors; The potential lack of harmonisation.

Disclosure requirements must remain proportionate

The SCR should not be a hard target

Source CEA

CEA and the European industry’s input to Solvency II

Essential Building Blocks of Solvency II

Key Aspects of CEA’s High-level Position on the Solvency II Directive

Key benefits for consumers

Areas of particular relevance for SMEs

Solvency II recognising the economic reality of groups

Solvency II and pension funds

Conclusions

2

3

Outline:

1

4

Why Solvency II matters to consumers (1)

Solvency II will enhance policyholder protection by:

Earlier identification of risksIntroduction of two capital requirementsAllowing management and/or supervisors more time to take mitigating actions

More appropriate and effective supervisory powersSupervisory review of the adequacy of companies’ risk management processes and controlsLadder of supervisory intervention

Cost effective protectionSolvency II capital requirements sufficient to withstand a very rare adverse annual event estimated to happen with a probability of 1 in 200 yearsNo zero-risk of failure: this would set wrong incentives for risk management

Development of more innovative and competitive products:

Market forces and consumer needs determine how companies design their products

Industry survey confirmed that Solvency II should increase competition and the scope for European-wide products

More integrated single market increase competitionBenefits for consumers in the form of more attractive products

The economic approach under Solvency II fosters better understanding of the underlying risk exposure

under certain circumstances, this may lead to pricing adjustments, orthe development of new innovative products

Why Solvency II matters to consumers (2)

Why Solvency II matters to consumers (3)

Important to meet the following conditions (non-exhaustive list):

Risk-based economic approach to ensure same adequate level of protection to all policyholders across Europe

Independent of legal status or size

Development of an escalating ladder of interventionAlignment of MCR and SCR calculation methods needed: MCR should be expressed as a percentage of the SCREnsures that insurers and supervisors have the possibility to take the right measures at the right time

Solvency should remain a principle based supervisory frameworkA supervisory regime that has the possibility to adopt and evolve; e.g. to capture new or emerging risks

Information sharing, coordination and cooperation between MS’supervisory authorities

Source CEA

CEA and the European industry’s input to Solvency II

Essential Building Blocks of Solvency II

Key Aspects of CEA’s High-level Position on the Solvency II Directive

Key benefits for consumers

Areas of particular relevance for SMEs

Solvency II recognising the economic reality of groups

Solvency II and pension funds

Conclusions

2

3

Outline:

1

4

Overview of EU insurance market

Split of the number of undertakings by company size

- Total of 5,000 companies -

6%15%

79%

Large companies

Medium-sized companies

Small companies

Split of the market share by company size

85%13% 2%

Large companies

Medium-sized companies

Small companies

SME role in the EU insurance market

Small and Medium-sized Entities (SMEs) represent around 95% of the number of European insurance companies

SMEs play a very important role:Increasing specialised product availabilityIncreasing competition and contributing to better prices for consumers

SMEs generally operate through:Specialised product offerings / niche marketsHistoric links with certain customer segments

26

CEA Impact Assessment

442 insurance undertakings contributed to the CEA survey

The survey covered undertakings of all sizes and different lines of business

The most representative industry survey on Solvency II

The survey participants responded on the assumption that Solvency II will follow a risk-based economic approach

27

Most companies are developing risk management frameworks …

This applies to all companies - large, medium and small

28

… and not just because of Solvency II

Solvency II provides an opportunity to align regulatory requirements with best practice in risk management

SMEs support a risk-based economic approach

The solvency regime requirements for SMEs and groups are very similar:

e.g. alignment of capital requirements with underlying risks; recognition of risk mitigation schemes; allowance for diversification effects, etc

Same risk, same requirement

However, SMEs have some specific needs …

Exemptions from Solvency II

Solvency II aims to provide equal protection for policyholders

Capital requirements should be risk based and not unduly influenced by the size or legal form of the company

Smaller undertakings have expressed their concerns that exclusion from Solvency II would:

Lead them to being seen as second class companiesLead them open to local regulation without the guarantee of harmonisation and a level playing fieldRequire them to opt-in to Solvency II to satisfy policyholders looking for Solvency II security when purchasing their contracts

The principle of proportionality

One-size-fits all approach not possible Flexibility based on the different nature, scale and complexity of the undertakings is requiredThe standard approach must allow simplified calculations provided certain criteria are metStandard approach needs to retain its risk sensitivity without becoming an unnecessary administrative burden, in particular for smaller companies

Source CEA

CEA and the European industry’s input to Solvency II

Essential Building Blocks of Solvency II

Key Aspects of CEA’s High-level Position on the Solvency II Directive

Key benefits for consumers

Areas of particular relevance for SMEs

Solvency II recognising the economic reality of groups

Solvency II and pension funds

Conclusions

2

3

Outline:

1

4

Groups have a very large market share

Split of the market share by company size

85%13% 2%

Large companies

Medium-sized companies

Small companies

Solvency II and Groups

Insurance groups are increasingly managed at the group levelAllows better assessment of risksPolicyholder protection should also be considered at the group level

Issues to be consideredLead supervisorFungibility of capital

Under Solvency I, supervision primarily takes place at the solo level

Supervisory requirements vary greatly between countries

Also for groups, supervision should reflect their economic reality

Diversification is key for Insurers

Diversification benefits are at the heart of the concept of insurance

Across risk types(products / lines of business)

Across companies withina single jurisdiction

Across regulatory jurisdictions/geographies

Within a single risk type(across individual risks)

Div

ersi

ficat

ion

effe

ct Effe

cts

part

icul

arly

re

leva

nt fo

r gro

ups

Full recognition of diversification effects

Diversification types vary

Diversification exists at group level:Across companies within a single jurisdictionAcross regulatory jurisdictions

A more stable development of claims leading to lower capital requirements

Solvency II should fully recognise all diversification effects and reflect this in the capital requirements at both solo and group levels

Lead Supervisor

A lead supervisor for group supervision would benefit:

Policyholder protection more effective assessment of risks - implies earlier detection of possible issues

Supervisory best practiceEnhance dialogue amongst lead and solo supervisors

Lead supervisor would reduce cost of supervisionsupporting more efficient and competitive internal market for insurance services

Supervisory Harmonisation

The significant differences in supervisory practice inhibit the development of the insurance market

Groups operating in EU face patchwork of requirements

Solvency II is an opportunity to address some of these supervisory issues

e.g. making reporting requirements more consistent

Adopting a lead supervisor approach is an important part of achieving harmonisation

Supervisory harmonisation is essential under Solvency II with a supervisory system that is adapted to how groups are managed today

and tomorrow

Source CEA

CEA and the European industry’s input to Solvency II

Essential Building Blocks of Solvency II

Key Aspects of CEA’s High-level Position on the Solvency II Directive

Key benefits for consumers

Areas of particular relevance for SMEs

Solvency II recognising the economic reality of groups

Solvency II and pension funds

Conclusions

2

3

Outline:

1

4

Pension Funds and Solvency II

Pension Funds are not included in Solvency II for sound reasons

Level playing field should be also ensured in the futureArticle 17(2) IORP to Articles 27 and 28 Life Assurance Directive now replaced by Solvency II Proposal provisions

EC plans to review the IORP Directive in 2008

Source CEA

CEA and the European industry’s input to Solvency II

Essential Building Blocks of Solvency II

Key Aspects of CEA’s High-level Position on the Solvency II Directive

Key benefits for consumers

Areas of particular relevance for SMEs

Solvency II recognising the economic reality of groups

Solvency II and pension funds

Conclusions

2

3

4

Outline:

1

Conclusions

The Industry strongly supports Solvency II objectivesCurrent rules are not aligned with economics & risks of the business Objectives can only be reached through a risk based economic approach

The Industry recognises work done to date by supervisors and welcomes the constructive dialogue

Need to keep the positive momentum we observe today, even if hard work is required from all parties

Much has been achieved so far but the pace is increasing with challenges for all stakeholders.

Areas where further work is required including calibration, group issues, eligible elements of capital, small companies and the articulation/ functioning of Pillar 2 and Pillar 3

The Industry will continue to actively and constructively contribute to the debate

QISs are an opportunity for the industry and supervisors

Background documents

Further reading...

Key strategic publications available on the CEA website (www.cea.assur.org) include:Introductory Guide to Solvency II

A 10-pages brochure (including synthetic executive summary) introducing the main concepts of Solvency IIProposals for a European Standard Approach – ESA for SCR

The ESA aims at capturing the requirements of a consistent economic risk-based approach within a workable solution

CEA’s view on the Impact of Solvency II on the Average Level of CapitalA guide on the comparison of the current Solvency I and future Solvency II frameworks

CEA Working Document on MCR and a Proposed Ladder of InterventionCEA aims to contribute to the ongoing development of critical issues such as the Minimum Capital Requirement (MCR) and proposes a methodology to calculate MCR as well as an approach to a ladder of intervention

CEA Working Paper on the risk measures VaR and TailVaRThis paper discusses the issues related to using VaR and TailVaR as risk measures within the solvency assessment of insurance companies

CEA 10 Key messages on Solvency II

Solvency II Impact Assessment

Solvency II Glossary

CEA information paper on Groups and Solvency II

CEA information paper on Diversification and Specialisation benefits

CEA information paper on Small and Medium-sized Undertakings (SME)s and Solvency II

Contacts

CEA Director General: Michaela Koller (Koller@cea.assur.org)

CEA Economics & Finance Committee SecretariatPeter Skjødt - acting ECOFIN Director (PSK@ForsikringensHus.dk )Yannis Pitaras (Pitaras@brussels.cea.assur.org)Jérôme Berset (Berset@cea.assur.org)Marta Gonzalez (Gonzalez@cea.assur.org)Silvia Herms (Herms@cea.assur.org)Benoît Malpas (Malpas@cea.assur.org)

CEA Public Affairs: Gabriela Diezhandino (diezhandino@cea.assur.org)Ido Bruinsma (Bruinsma@cea.assur.org)

www.cea.assur.org / www.cea.eu+32 2 547 5811

www.cea.assur.org

MCR

SCR

MCR

SCR

MCR

SCR

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MCRSCR

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MCR defined as percentage of SCR:

MCR & SCR respond consistently to changing economic conditions

Supervisory can act by “ladder of intervention”

MCR & SCR based on different risk-oriented principles

MCR & SCR can respond differently to changing economic conditions

Supervisory cannot act by “ladder of intervention”

MCR and SCR calculation methods need to be aligned

Tech.liabilities

Tech.liabilities

Detailed calculation specifications should not be in the Directive