technical practices survey 2011

ADVISORY

Technical Practices

Survey 2011

kpmg.co.uk

http://www.kpmg.co.uk

2 | TECHNICAL PRACTICES SURVEY

Contents

1 Foreword 4

2 Executive Summary 6

3 Introduction 9

4 Survey Findings 12 4.1 Solvency II Project 12

4.2 Technical Provisions 23

4.3 Solvency Capital Requirement 37

4.4 Solvency Capital Requirement – Standard Formula 39

4.5 Solvency Capital Requirement – Internal Model 45

4.6 Pillars 2 and 3 67

4.7 Product Pricing 83

4.8 Tax 87

4.9 Own Funds 99

4.10 Groups 103

4.11 Profile of Respondents 105

5 Acknowledgements 109

6 List of participants 111

7 Glossary 113

8 List of graphs and tables 115

CONTENTS | 3

© 20© 20111 KPMG LLP1 KPMG LLP, a UK limited liabilit, a UK limited liability partnership, is a subsidiary partnership, is a subsidiary of KPMG Europe LLP and a member firm of the KPMG nety of KPMG Europe LLP and a member firm of the KPMG netwwork of independent member firms afork of independent member firms affiliated with KPMG Internationalfiliated with KPMG International CooperativCooperative, a Se, a Swiss entitwiss entityy.. All rights reserAll rights reservved.ed.


1 Foreword

It gives me great pleasure to present this report on our latest Technical Practices Survey. Now in its sixth year, our Technical Practices Survey continues to be highly regarded by individuals, companies and indeed other consultancies as a guide to the range of practices adopted in various areas of UK life actuarial work.

This year’s survey has taken on a new form to reflect the current main focus of the UK life insurance industry, ie the implementation of Solvency II.

In previous years, we have focussed on the areas of UK regulatory reporting, Embedded Values and Individual Capital Assessment. However, the new Solvency II regime will encompass many of the current actuarial practices of reporting, and we have therefore decided that now is the time to focus our Technical Practices Survey entirely on Solvency II. At the time of writing, it is well known that many aspects of the new regime remain uncertain, with companies grappling to know what to do in many areas. We believe that this makes the timing of this survey particularly apposite.

Working in a top advisory firm, some of the most common questions we get asked by our clients are about what other companies are doing, how they approach certain problems and what best practice on certain items appears to be. This is currently just as relevant for Solvency II – if not more so – than it was for the material previously covered by our survey. The questions were devised to incorporate the most important Solvency II topics that our clients have raised over the past 12 months. The survey is naturally focussed on the technical aspects of Solvency II, but as you will see we have covered some of the wider aspects as well.

The survey requires a large investment of resources on our part – an investment which we think is well worth the time and effort because of the usefulness of the results. We are grateful to all the companies who found the time in their schedules to take part and would like to extend our thanks to all of you once again. In Section 6 of this report we have listed the 32 companies who have contributed to this survey. As I am sure you will agree, the range of firms involved by size and type makes the results set out an excellent indication of the UK life industry’s progress and approach to Solvency II. I hope that if you have not been able to take part in the survey this year that you would be able to do so in 2012.

I would like to extend a very special thank you to my colleagues David Alison, James Latto, Richard Li, Saroop Rooprai, Jaya Asthana and Michael Beck for their hard work in carrying out the survey and compiling this report, whilst at the same time carrying out their client service responsibilities.

I believe that you will find this report useful and interesting and look forward to receiving any comments or suggestions you may have on how we can make the questions, analysis or report even more useful or relevant to you. I would also like to thank Gordon Gray, of the KPMG Tax team, for his help in completing the tax sections.

Regards

John A Jenkins FIA Partner KPMG LLP

© 2011 KPMG LLP, a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative, a Swiss entity. All rights reserved.

1 Foreword

1 FOREWORD | 5



2 Executive Summary

The key findings of this report are detailed below and give an analysis of the responses from 32 life offices.

It has been pleasing to see good progress made by most companies in their preparation for Solvency II. Seventy-eight percent of respondents feel that their implementation projects are on track and 61 percent have seen their budget for Solvency II remain at the same level they had originally forecast. One major challenge to life offices, with regards to Solvency II, are the documentation standards and we have seen this as a common theme across all Pillars.

With regards to the Technical Provisions calculations, progress has been gradual for both the Best Estimate Liabilities and Risk Margin. As would be expected, we can see that progress has been made mainly for the methodology, the second most advanced was assumptions, third is data, followed by processes and the controls. This was seen for both Best Estimate Liabilities and Risk Margin, although progress for Best Estimate Liabilities has been greater.

Also, 68 percent of companies surveyed confirmed that they used the same method to calculate Risk Margin for all risks and products and 50 percent of the companies surveyed use the same Risk Margin projection method as their ORSA.

Of our 32 respondents, 13 are using the Standard Formula approach, 14 are using a Full Internal Model and the remaining five are using a Partial Internal Model.

Under the Standard Formula, the most challenging stress to model was Counterparty Risk, with 54 percent of respondents highlighting that this was the most complicated stress to compute.

Although 83 percent of respondents who are using an Internal Model believe themselves to be on track, the main challenges highlighted were the technical build and also the documentation standards.

With regards to Pillars 2 and 3, we saw that actuarial functions had partial involvement across these Pillars. It is pleasing to see that actuaries are involved in all the different aspects of Solvency II and also there is not a concentration of functions involved in Solvency II, helping to support the “three lines of defence” philosophy .

Although the majority (90 percent) of respondents will produce a formal ORSA report on an annual basis, we saw that 40 percent will be assessing their Solvency position against the ORSA every quarter. Fifty-five percent of respondents will have started the dry runs of their ORSA by the end of 2011.

The lack of guidance in some areas has come through as a concern for many offices. The guidance for Tax was unanimously answered as insufficient, and issues with the lack of guidance and clarity were apparent across all three Pillars.


2 Executive Summary

2 EXECUTIVE SUMMARY | 7




© 2011 KPMG LLP, a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member firm of the KPMG network of independent

member firms affiliated with KPMG International Cooperative, a Swiss entity. All rights reserved.

3 INTRODUCTION | 9

3 Introduction

3.1 Objectives Our aim is to provide detailed analysis on how the market will adopt the Solvency II regime, where the key issues lie and where common methodologies have arisen. Gathering a better view of how the industry as a whole is preparing for Solvency II will prove to be extremely insightful.

The KPMG Life Actuarial team has carried out the Technical Practices Survey since 2006. By moving away from the old structure of three surveys to one entirely focussed on Solvency II, we have changed the basis of our Technical Practices Survey. Although the number of surveys has reduced, the wide ranging aspects of Solvency II means that we can encapsulate many of the issues for UK life companies. This gives us the opportunity to draw out benchmarking on methodologies and technical actuarial practices on a variety of topics in a single survey.

This survey aims to provide an insight into how companies are preparing for the arrival of Solvency II; how they will comply with the new regulations; and, whether the industry has found common ground or is widely dispersed in its approaches.

3.2 Survey methodology The data for this project was collected through a survey that was sent out to companies for completion in June and July. In order to make the data as representative as possible, every UK life office with an internal actuarial function was invited to participate. Although the structure of the survey had changed, and had an entirely new set of questions, we again used both a spreadsheet version and paper form of the survey. We have attempted to keep the survey to a reasonable length and were hopeful it was not too onerous to complete!

For data protection and commercial confidentiality reasons, individual responses have been, and will continue to be, treated with strictest confidence. For the purposes of this report, the results have all been presented in an aggregate format or have been made anonymous.

Each survey contained a mixture of multiple choice and open response questions. The surveys were designed to be as time-efficient for participants as possible. Multiple choice questions typically are quicker to answer than open response questions and so we try to use the multiple choice format wherever possible, with a suitable “other” or “n/a” option. We regularly review the feedback we receive in order to improve the options for these questions.



3.3Topics of interest This year’s survey was of an entirely new format and subject area. The questions were formed from the issues that clients have raised over the past 12 months and also attempt to cover the areas of Solvency II that are of most importance in terms of actuarial techniques.

Our first focus was around preparation for Solvency II implementation. We wanted to highlight any common issues that companies may be having, as well as give a reflection of the resource strain the implementation of Solvency II projects is having on the UK life insurance industry.

The main body of our survey then focuses on the calculation strategies around Pillar 1 liabilities and capital requirements. This involves technical questions around methodologies that companies are employing for the calculation of their Technical Provisions (both Best Estimate Liabilities and Risk Margin) and Solvency Capital Requirements (for both the Standard Formula and Internal Models).

We also wanted to gather an understanding of how the other aspects of Solvency II were being treated from an actuarial point of view, and later sections reflect on Pillars 2 and 3 as well as Own Funds.

The impact of Solvency II on product pricing, tax and the strategy adopted by groups are also addressed by this survey.

3.4 Survey respondents Our survey was targeted at over 60 UK life offices with internal actuarial functions. Given that we have moved from three surveys to one, analysis of response numbers is inconclusive given that the participants of the individual surveys last year differed. We are delighted with the number of participants this year and the final number of 32 is higher than the number of respondents for any of the individual surveys last year. We feel that this is a great indication of the desire for benchmarking information on Solvency II and how important an issue this area is for the whole of the UK life insurance industry.

The true test of a survey is that it continues to retain a significant level of interest. It is pleasing to see that this year we have continued to receive a consistently large number of responses as last year despite the onerous extra workload as a consequence of Solvency II. We truly believe that this reflects how useful participants of the survey have found the results of our previous surveys.

While the number of participants should be considered as very healthy for this type survey, the response rate alone does not convey all the information about the representative nature of the survey. Firstly, individual responses did not always cover only one legal entity but were often done on behalf of all the insurance companies in a group. Secondly, the operations of each company are often materially different and they may well operate in different markets. Finally, companies can of course also range from small to large in size. Some form part of larger (often multi-national) groups, while others are large in their own right and may well be listed on various European exchanges.



3 INTRODUCTION | 11

When presenting our analysis we have also tried to set the context for our findings by providing a snapshot of the respondents at the start. Graphical representation of the respondents can be seen in Section 4.11, whereas a full list of respondents can be found in Section 6 of this report. Most of the major life offices have taken part in the survey and in terms of UK regulatory liabilities as at 31 December 2010, the companies make up around 70 percent of the market.

3.5 A note on the interpretation of the results Finally, we would like to point out that the information contained in this report is of a general nature and it is not intended to address the circumstances of any particular individual or entity. Although we have tried to provide timely and accurate information we cannot guarantee that this information was accurate at the date it was received or that it will continue to be accurate in the future. No one should act on any information contained in this report without appropriate professional advice and a thorough examination of their particular situation.



4 Survey Findings

4.1 Solvency II Project

4.1.1 Introduction As Solvency II draws nearer, companies face increasing pressure to make the most efficient use of financial and human resources. This section outlines key characteristics of companies’ Solvency II programmes, including budget and resource allocation. It also considers the difficulties encountered during the completion of QIS 5 and the main challenges for Solvency II implementation.

4.1.2 Solvency II programme timetable We asked participants whether they felt that their Solvency II programme was on track with reference to the latest FSA deadlines (requiring full implementation at 1 January 2013 at the date the survey was issued). The majority of respondents reported that their programme was on track. Six respondents were running behind schedule; four of these gave resource constraints or conflicting priorities as reasons while two indicated that they had started late. Only one respondent was ahead of schedule.

Graph 1.1: Solvency II programme - overall status

1

6

25

Running ahead of schedule

On track

Running behind schedule


4 SURVEY FINDINGS | 13

4.1.3 Budget 4.1.3.1 Current estimated budget We asked participants what the current estimated budget for their entire Solvency II programme was. There were 31 respondents to this question. While three of the larger insurers had budgets of over £75 million, several other large insurers had much smaller budgets. Just over half of all respondents had budgeted less than £5 million for their programmes, with seven respondents budgeting less than £1 million.

Graph 1.2: Current estimated budget split by size of Peak 1 insurance liabilities plus WPICC

More than £100m

Between £75m and £100m






Less than £1m

1

1 1

1 1 2

1

1

1 1 1

1

2

2 2

4

4

4

0

0 2 4 6 8 10

£10bn or more £500m or more but less than £1bn

£5bn or more but less than £10bn £250m or more but less than £500m

£1bn or more but less than £5bn under £250m


© 2011 KPMG LLP, a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member firm of the KPMG network of independent member firms affiliated with KPMG International


4.1.3.2 Changes to budget We asked participants whether the budget has changed from the initial estimates approved by the Board. Of the 31 respondents, 19 stated that the budget had stayed the same while ten reported that it had increased. Only two respondents reported a decrease in the budget.

Graph 1.3: Changes to budget from the initial estimates approved by the Board

10

19

2 Yes increased

Stayed the same

Yes decreased

Cooperative, a Swiss entity. All rights reserved.

© 2011 KPMG LLP, a UK limited liability partnership, is a subsidiary of

KPMG Europe LLP and a member firm of the KPMG network of independent

member firms affiliated with KPMG International Cooperative, a Swiss

entity. All rights reserved.


4.1.4 Resourcing 4.1.4.1 Full Time Equivalents allocated to the Solvency II programme The relationship between the size of the respondents and the number of Full Time Equivalents (FTEs) allocated by them to the entire Solvency II programme is shown in Graph 1.4. Please note that the number of resources described below also includes non actuarial resources, as well as contractors and consultants.

As might be expected, only the larger respondents (with in-force liabilities of £5 billion or more) have allocated more than 100 FTEs to the project. However, some large insurers have a much smaller allocation. Most respondents with less than £1 billion of in-force liabilities have allocated less than 20 FTEs to the project.

Graph 1.4: Number of Full Time Equivalents allocated to the Solvency II project split by size of Peak 1 insurance liabilities plus WPICC

More than 100 Full Time Equivalents

Between 50 and 100 Full Time Equivalents



Less than 10 Full Time Equivalents

3 6 9 12 15

3

1 1

1

1

1 1

22

2

24

4 43

0

£10bn or more £500m or more but less than £1bn

£5bn or more but less than £10bn £250m or more but less than £500m

£1bn or more but less than £5bn under £250m




4.1.4.2 Use of contractors and consultants in the Solvency II projectThe relationship between the size of the respondents and the average proportion of Solvency II work carried out by internal staff, contractors and consultants is shown in Graph 1.5. As might be expected, larger companies are using a much higher proportion of external resource to meet Solvency II requirements as compared to smaller companies.

Graph 1.5: Proportion of Solvency II work carried out by internal staff, contractors and consultants, split by size of Peak I insurance liabilities plus WPICC

Internal staff

Contractors

Consultants

67% 13% 19%

92% 7%

Peak 1 insurance liabilities (plus WPICC) over £1bn

Peak 1 insurance liabilities (plus WPICC) under £1bn

0% 20% 40% 60% 80% 100%

© 2011 KPMG LLP, a UK limited liability partnership, is a subsidiary of

KPMG Europe LLP and a member firm of the KPMG network of independent

member firms affiliated with KPMG International Cooperative, a Swiss

entity. All rights reserved.


4.1.4.3 Areas in which the assistance of contractors and consultants are used Graph 1.6 shows the areas in which respondents were using the assistance of contractors and / or consultants.

Twenty-five of the 30 respondents to this question used the assistance of contractors and / or consultants for actuarial work. Half or more of the respondents also used the assistance of contractors and / or consultants in the Risk and Governance, Project Management, and Information Technology areas. Besides the categories specified in the chart below, other areas in which the assistance of contractors and / or consultants was used included accounting and quality assurance.

Graph 1.6:Areas in which the assistance of contractors and / or consultants are used

Other

Tax

Internal audit

Risk and governance

Project management

Information technology

Compliance

Actuarial

0 5 10 15 20 25

6

6

19

18

15

4

2

25

83% of respondents use the assistance of contractors and / or consultants in their actuarial work



4.1.4.4 Areas in which actuaries were the main contributors Graph 1.7 shows the areas in which actuaries were the main contributors

According to all 31 respondents to this question, actuaries were the main contributors in the work on the Solvency Capital Requirement (Standard Formula). Additionally, all respondents using a full or partial Internal Model considered actuaries to be the main contributors for work on the Solvency Capital Requirement (Internal Model).

Actuaries were also seen as the main contributors to Best Estimate Liabilities by all the 31 respondents. Other areas selected by more than half of respondents were Risk Margin and Pillar 2 – Own Risk and Solvency Assessment.

Graph 1.7:Areas in which actuaries were the main contributors

Asset valuation

Best Estimate Liabilities

Risk Margin

Solvency Capital Requirement – Standard Formula

Solvency Capital Requirement – Internal Model

Pillar 2 – Own Risk and Solvency Assessment

Pillar 2 – Governance and Compliance

Pillar 3

Tiering of capital

Tax

Systems

Data

Project management

0 5 10 15 20 25 30 35

10

31

30

31

18

18

12

3

5

9

5

7

3



4.1.5 QIS 5 All 32 respondents took part in the fifth Quantitative Impact Survey (QIS5) exercise.

4.1.5.1 Rating of QIS5 completion We asked participants to rate their completion of QIS 5 results on a scale of 1 to 5, where 1 indicated auditable results and 5 a high level estimation. Only three respondents reported having auditable results. Fifteen respondents selected option 2, suggesting a reasonably robust and accurate though not auditable process. None reported carrying out a high level estimation.

Graph 1.8: Rating of QIS5 completion on a scale of 1 to 5

2

High level estimation 5

4

3

2

Auditable results 1 3

12

2

0

15

0 3 6 9 12 15

4.1.5.2 Main operational difficulties found in QIS 5 calculations Graph 1.9 shows the main operational difficulties respondents found in the QIS 5 calculations. Over half of respondents indicated that the lack of clarity in the QIS 5 guidance was one of the main difficulties. Errors/delays in the provided QIS 5 spreadsheet and resourcing difficulties were both cited by over a third of respondents as being significant operational difficulties. Other responses included competing demands for management time.

Graph 1.9: Main operational difficulties found in QIS 5 calculations

Not applicable

Other

Errors / delays in the provided QIS 5 spreadsheet

Data requirements

Guidance (lack of clarity)

Timing

Resources

0 5 10 15 20

2

2

12

3

17

7

13



4.1.6 Impact of Solvency II The respondents’ perception of the impact of Solvency II on various areas of the business is shown in Graph 1.10. There were at least 30 respondents for each area considered.

Most respondents expected Solvency II to have at least a small impact on every area considered. The areas on which the majority of respondents expected a significant impact were capital management / allocation and decision making processes and management information. On the other hand less than a third of respondents expected a significant impact on the corporate structure, product mix, or product design. Whilst it is dependent on the final Solvency II rules, we think that there will be a material impact on product pricing, mix and design; however this would be very product specific and firms were answering this question for products as a whole.

Graph 1.10: Impact of Solvency II on business areas

72% 25% 3%Capital management / allocation

16% 47% 38%Corporate structure (eg de/merger of group entities)

77% 16% 6%Decision making processes and management information

13% 60% 27%

38% 53% 9%

22% 63% 16%

Product mix

Product pricing

Product design

0% 20% 40% 60% 80% 100%

Significant Impact

Small Impact

No Impact



4.1.7 Communication to stakeholders on Solvency II We were interested in the extent to which companies currently communicate progress on the Solvency II programme to stakeholders. As shown in Graph 1.11, the majority of respondents had at least some communication with all stakeholders except for policyholders. All respondents to whom the question applied reported at least some communication with shareholders and regulators. Regulators were the only stakeholders with whom most respondents had detailed communication.

Graph 1.11: Communication to stakeholders

Shareholders

Regulators

Policyholders

Credit rating agencies

Market analysts

Auditors

13 7 12

12 20

21 8 3

9 11 1118 13 11

2 26 4

0 5 10 15 20 25 30 35

Detailed Communication No Communication

Some Communication Not Applicable

63% of respondents hold detailed communication with regulators on progress of Solvency II implementation



4.1.8 Challenges for Solvency II implementation We asked participants which areas they currently find the most challenging in their Solvency II implementation. Documentation and uncertainty over transitional arrangements were identified by over half of all respondents as being areas of difficulty. The response on uncertainty over transitional arrangements may have been influenced partly by because the timing of the survey (July 2011) coinciding with the publication of a draft report on the proposed Omnibus II directive which proposed a deferral of the full implementation date and discussions around whether general transitional provisions are needed.

Twelve of the 19 respondents planning to calculate the Solvency Capital Requirement using a full or partial Internal Model identified the Solvency Capital Requirement (Internal Model) as being a challenging area. We note that, as a percentage, this area is the most challenging, given the smaller proportion to which it applies.

Over a third of all respondents also cited Data and Pillar 2 (Own Risk and Solvency Assessment) as being challenging areas for the implementation. Surprisingly, more firms cited issues with asset valuation than with Risk Margin, where we had thought that firms were having challenges.

Graph 1.12: Challenges for Solvency II implementation

Asset valuation


Risk Margin

Solvency Capital Requirement – Standard Formula

Solvency Capital Requirement – Internal Model

Pillar 2 – Own Risk and Solvency Assessment

Pillar 2 – Governance and Compliance

Pillar 3

Tiering of capital

Tax

Systems

Data

Project management

Group issues

Uncertainty over transitional arrangements

IMAP

Assurance / validation

Documentation

0 5 10 15 20

5

3

4

4

12

13

9

7

2

6

7

12

1

10

9

8

17

18



4.2 Technical Provisions Under Solvency II, the Technical Provisions are calculated as the sum of the Best Estimate Liabilities and the Risk Margin. The Best Estimate Liabilities and the Risk Margin is usually calculated separately but it is also possible to calculate the Technical Provisions as a whole.

4.2.1 Best Estimate Liabilities 4.2.1.1 Progress Under the Individual Capital Assessment (ICA), UK insurance companies calculate realistic liabilities. The realistic liabilities are similar in many ways to the Best Estimate Liabilities under Solvency II, which puts the UK insurance industry well placed to respond to the requirements under Solvency II. However, insurance companies in the UK will still require significant work to ensure they meet the standards required under the new regime.

We asked respondents to indicate the overall progress they have made in the areas of data, methodology, assumptions, process and controls for their Best Estimate Liabilities, compared to their internal targets. The majority of respondents believe they have made either significant or sufficient progress in those areas. There are, however, a number of respondents who have indicated that insufficient progress has been made, particularly in the areas of process and controls.

We also analysed the responses separately by the size of the insurance companies and the number of Full Time Equivalent they allocate to the entire Solvency II programmes. This showed a broadly similar trend, irrespective of the size of the insurance companies. However, as expected, it is clear that the companies which allocate less resource to their Solvency II programme are making less progress than those allocating more resources to their Solvency II programme.

Graph 2.1: Progress on the development of the Best Estimate Liabilities for all companies

Controls

Process

Assumptions

Methodology

Data

69% 31%

3% 75% 22%

31% 56% 13%

53% 44% 3%

9% 75% 16%

0% 20% 40% 60% 80% 100%

Significant progress

Sufficient progress

Insufficient progress



Graph 2.2 Progress on the development of the Best Estimate Liabilities for companies with less than £1bn Peak 1 insurance liabilities plus WPICC

Data 11% 67% 22%

Methodology 33% 56% 11%

56%Process 44%

Controls 44%

Assumptions 11% 89%

56%

0% 20% 40% 60% 80% 100%


Sufficient progress


Graph 2.3: Progress on the development of the Best Estimate Liabilities for companies with more than £1bn Peak 1 insurance liabilities

0% 20% 40% 60% 80% 100%

Data

Methodology

Assumptions

Process

Controls

39% 43% 17%

61% 39%

9% 78% 13%

4% 83% 13%

74% 26%


Sufficient progress




Graph 2.4: Progress on the development of the Best Estimate Liabilities for companies allocating less than 20 FTE resources to their entire SII programme

60% 40%Controls

35% 60%

70% 25%

15% 65% 20%

5% 65% 30%

5%

5%

Process

Assumptions

Methodology

Data

0% 20% 40% 60% 80% 100%


Sufficient progress


© 20© 20111 KPMG LLP1 KPMG LLP, a UK limited liabilit, a UK limited liability partnership, is a subsidiary partnership, is a subsidiary of KPMG Europe LLP and a member firm of the KPMG nety of KPMG Europe LLP and a member firm of the KPMG netwwork of independent member firms afork of independent member firms affiliated with KPMG International filiated with KPMG International CooperativCooperative, a Se, a Swiss entitwiss entityy. . All rights reserAll rights reservved.ed.


Graph 2.5: Progress on the development of the Best Estimate Liabilities for companies allocating more than 20 FTE resources to their entire SII programme

83% 17%

92% 8%

58% 42%

83% 17%

Controls

Process

Assumptions

Methodology

17% 83%Data

0% 20% 40% 60% 80% 100%


Sufficient progress


4.2.1.2 Challenges We then asked the respondents about their biggest challenge for the modelling of the Best Estimate Liabilities. Half of the respondents indicated that documentation was the biggest challenge whilst 28 percent of the respondents indicated that it was the modelling methodology.

Nine percent of the respondents indicated other challenges from the options provided in the survey, including uncertainty in the technical specifications from EIOPA, process efficiency to meet accelerated timescales and integration with existing models.

Graph 2.6: Biggest challenge for modelling the Best Estimate Liabilities

9% 9%

28%

3%

50%

Granularity

Model run time

Modelling methodology

Documentation

Other



Half of the respondents have indicated that they had to take some form of actions to improve their data as a result of the Solvency II requirements. Out of the 16 respondents who took some form of actions to improve their data, half indicated they had centralised their data or have developed a data warehouse. Other respondents indicated that they had reviewed their data policy and performed data cleaning exercises.

Graph 2.7: Actions taken to improve data as a result of Solvency II requirements

12.5%

12.5%

50%

25%

Centralised data / Developed data warehouse

Reviewed data policy

Performed data cleaning exercises

Other

4.2.1.3 Management actions Companies are able to make assumptions on future management actions in the calculation of their Best Estimate Liabilities. We asked companies which future management actions they are allowing for and 14 indicated that they do not allow for any future management actions in the calculation of their Best Estimate Liabilities, of which 11 are regulatory reporters and three are realistic reporters.

Clearly, the current distinction between realistic and regulatory reporters falls away under Solvency II, but we have nevertheless found it useful to retain this distinction in the analysis shown below.

Eighteen respondents indicated that they allowed for some management actions, of which 14 are realistic reporters and four are regulatory reporters. This is not surprising, given that there is a wider spectrum of management actions available for with-profits funds.

Graph 2.8: Allowance for management actions in the calculations of the Best Estimate Liabilities

11 3

4 14

0 5 10 15 20

Regulatory reporter Realistic

No management actions

Management actions




For those realistic companies that allow for future management actions in the calculation of their Best Estimate Liabilities, a variety of approaches are adopted, the most popular being adjustments to MVAs, changes to bonus rates and equity backing ratios.

Graph 2.9: Management actions allowed in the calculations of the Best Estimate Liabilities – Realistic reporters

Implementing or changes to an outsourcing agreement

Change in reinsurance agreements

Change to or introduction of charges levied for cost of guarantees

Removal of miscellaneous surplus / planned enhancements

Change in hedging strategy

Increases in administration charges

Increases in charges for insurance benefits

Changes to equity backing ratios

Changes in final bonus rates

Changes in regular bonus rates

Adjustments to MVAs

0 2 4 6 8 10 12

1

1

4

3

2

1

1

6

11

9

9

© 2011 KPMG LLP, a UK limited liability partnership, is a subsidiary

of KPMG Europe LLP and a member firm of the KPMG network

of independent member firms affiliated with KPMG International



The regulatory companies which allowed for management actions in the calculation of their Best Estimate Liabilities also used a variety of approaches, the most popular ones being increases in the charges for insurance benefits and administration charges and change in new business levels. Two respondents indicated that they allowed for management actions other than the options provided in the survey. These other management actions include change to the bonus smoothing rates, increases in unit-linked fund related charges and changes to company’s contribution rates paid to the Defined Contribution pension scheme.

There were a few regulatory reporters which indicated that they allowed for adjustments to MVA and changes in bonus rates. These respondents have with-profits funds but are exempt from reporting under Peak 2, given they have less than £500m of with-profits insurance liabilities.

Graph 2.10: Management actions allowed in the calculations of the Best Estimate Liabilities – Regulatory reporters

Other Implementing or changes to an

outsourcing agreement Change in reinsurance agreements

Changes to defined benefit pension scheme Change to or introduction of charges

levied for cost of guaranteesRemoval of miscellaneous surplus /

planned enhancements Change in hedging strategy

Change in new business mix

Change in new business levels






Adjustments to MVAs

0 1 2 3 4

2

1

1

2

2

2

1

1

4

4

4

3

3

3

3



4.2.1.4 Reinsurance Under Solvency II, companies are required to calculate their Best Estimate Liabilities gross, without deduction from the amounts recoverable from reinsurance contracts. The amounts recoverable from reinsurance contracts must be calculated separately, taking account of the time difference between recoveries and direct payments, then adjusted to take account of expected losses due to default of the reinsurer.

We asked respondents about the methods they used to calculate their reinsurance recoverable. Out of the 31 respondents who answered this question, 58 percent indicated that they performed a direct calculation, whilst the remaining respondents indicated that they calculated the reinsurance recoverable by taking the difference between their gross and net of reinsurance technical provisions.

Graph 2.11: Methods used to calculate reinsurance recoverable

58%

42%

Direct calculation

Difference between gross and net of reinsurance

technical provision

We also asked respondents about their main challenges they face in the treatment of reinsurance. Of the 20 companies who provided a response, 35 percent indicated that they do not have any main challenges. The most common challenge was the allowance for the default risk which was the response from 25 percent of the respondents.

Graph 2.12: Main challenges in the treatment of reinsurance

5%

10%

5%

5%

10%

5%

25%

35%

Internal reinsurance

Allowance for default risk

No major challenge

Insufficient information from reinsurer

Model improvements

Application of Solvency II guidance

Identification of reinsurance arrangements

Other



4.2.2 Risk Margin The Risk Margin represents the amount required by an undertaking in order to take over the insurance obligations of the company and is calculated as the present value of the projected cost of capital in relation to underwriting, operational and other non-hedgeable risks.

4.2.2.1 Progress and challenges We asked the respondents to indicate the overall progress they have made in the areas of data, methodology, assumptions, process and controls on Risk Margin, compared to their internal targets.

The majority of respondents believe they have made either significant or sufficient progress in those areas and similar to their progress on the calculation of the Best Estimate Liabilities there are a number of respondents who have indicated that insufficient progress has been made, particularly in the areas of process and controls.

We also note that overall, respondents indicated that they have made more progress in the calculation of their Best Estimate Liabilities, compared to the progress they have made on the calculation of the Risk Margin.

Graph 2.13: Progress on the development of the Risk Margin

Controls

Process

Assumptions

Methodology

Data

13%

53%

44%

47%

44%

16% 69% 16%

18% 66% 16%

3% 75% 22%

0% 20% 40% 60% 80% 100%


Sufficient progress




4.2.2.2 Calculation of Risk Margin Under QIS5, companies were allowed to use a hierarchy of approaches to calculate their risk margin, ranging from the full calculation of all future Solvency Capital Requirements to a simple proportion of the Best Estimate Liabilities.

Out of the 32 respondents, 19 percent indicated that they would approximate the whole SCR for each future year using a proportional approach. Fifty-nine percent indicated that they would use approximations for the calculation of at least some risk modules in the calculation of the future SCR. It was surprising to note that given the stage we are in the Solvency II timescales, four respondents indicated that they were still undecided on which approach they would use to calculate their Risk Margin.

Graph 2.14:Approach used in the calculation of the Risk Margin

59%

19%

6%

13% 3%

Make a full calculation of all future Solvency Capital

Requirements without using simplifications

Approximate the individual risks or sub-risks within some

or all modules and sub-modules to be used

for the calculation of future Solvency Capital

Requirements

Approximate the whole Solvency Capital

Requirement for each future year, e.g. by using a

proportional approach

Estimate all future Solvency Capital Requirements “at

once”, e.g. by using an approximation based on the

duration approach

Undecided

3% of respondents make a full calculation of all future Solvency Capital Requirements without using simplifications



When calculating the Risk Margin, the SCR can be projected at a number of different granularity levels. We asked respondents about the granularity of the projections they used in the calculation of the Risk Margin. The majority of respondents indicated that this was performed at the product group level.

Graph 2.15: Granularity of projections used in Risk Margin calculation

20

15

10

5

0 Individual Modelling Product Fund level Undecided

policy level class level group level

6

3

16

4 2

(e.g. Table code)

We also asked respondents whether they used the same method for calculating their Risk Margin for all risks. Out of the 31 respondents to this question, 68 percent responded affirmatively to this question.

Graph 2.16:Are the methods used to calculate the Risk Margin the same across all risks?

68%

13%

19%

Yes

No

Undecided



We also asked respondents whether they will use the same method for projecting their SCR for the calculation of their Risk Margin and their ORSA. Out of the 32 respondents to this question, 50 percent responded affirmatively to this question, whilst 34 percent were still undecided.

Graph 2.17: Are the projection methods used to calculate the Risk Margin the same as the ORSA?

34%

50%

16%

Yes

No

Undecided

We then asked respondents about the tools they are using to calculate the Risk Margin. Fifteen respondents indicated that they are calculating the Risk Margin using the aggregation tool, seven respondents indicated that they are using the Asset Liability Model and six respondents indicated that the Risk Margin was calculated in a spreadsheet. Other respondents indicated that they are using a Risk Margin tool or a combination of the above.

Graph 2.18:Tools used to calculate the Risk Margin

22%

46%

13%

19%

Asset Liability Model

Aggregation tool

Spreadsheet

Other




4.2.3 With-Profits FundsWe were interested on the impact of Solvency II on with-profits funds. Out of the 15 respondents to this question, 27 percent indicated that their capital requirements would increase whilst 47 percent indicated that Solvency II would have minimal impact on their with-profits funds. Some respondents indicated that the impact was still under investigation, whilst others indicated that it would delay the distribution of the inherited estate.

Graph 2.19: How would you best describe the impact on Solvency II on your with-profits business?

27% 27%

47%

Higher capital requirements

Minimal impact

Other




4.2.4 Calculation of Technical Provisions as a wholeSolvency II allows for the Technical Provisions to be calculated as a whole where the future cash flows associated with insurance obligations can be replicated reliably using financial instruments for which a reliable market value is observable.

We asked respondents about the proportion of their Technical Provisions which they have been able to calculate as a whole. As expected, the majority answered that all of their Technical Provisions have been obtained by calculating the Best Estimate Liabilities and the Risk Margin separately.

Those respondents that had been able to calculate a proportion of their Technical Provisions as a whole indicated that less than five percent of their Technical Provisions had been able to be calculated as a whole and this was possible for unit linked business.

© 2011 KPMG LLP, a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member firm of the KPMG network of independent member

firms affiliated with KPMG International Cooperative, a Swiss entity. All rights reserved.


4.3 Solvency Capital Requirement The Solvency Capital Requirement (SCR) represents the capital requirements to be held by insurance companies to ensure that they will still be in a position, with a probability of at least 99.5 percent, to meet their obligations to policyholders and beneficiaries over the following 12 months.

The SCR can be calculated either in accordance with the Standard Formula (with possibility of using undertaking specific parameters) or using an Internal Model (or Partial Internal Model). We have asked respondents to indicate the method they were proposing to use to calculate their SCR.

Out of the 32 respondents, 19 indicated they are using either an Internal Model or Partial Internal Model whilst 13 indicated they are using the Standard Formula for the calculation of their SCR.

We analysed the respondents by the size of their Peak 1 Insurance liabilities and noted that of those who are using either an Internal Model or Partial Internal Model, almost 90 percent have liabilities greater than £1bn.

Graph 3.1: Method for the calculation of the SCR by size of companies

Standard Formula

Partial Internal Model

Full Internal Model

7

5

2 12

6

0 3 6 9 12 15

Under £1bn Over £1bn

89% of respondents using either a Full or Partial Internal Model have Peak 1 liabilities greater than £1bn




The EU Directive allows for companies to replace a subset of the parameters used in the standard formula by Undertaking-Specific Parameters if the risk profile of the companies deviates significantly from the assumptions underlying the Standard Formula. Out of the 13 respondents who indicated they are using the standard formula to calculate the SCR, none were using Undertaking-Specific Parameters.

There were five respondents who indicated they are using a Partial Internal Model and we asked them to indicate which risks they were planning on using the Standard Formula.

Of the four Partial Internal Model firms who answered this question, three indicated that they were planning to use only one of the Standard Formula risk modules whilst the remaining respondent indicated that it was planning to use three of the Standard Formula risk module.

Graph 3.2: Risks for which Standard Formula approach is used in the Partial Internal Model

Market: Concentration

risk

Market: Illiquidity premium

risk

Life: Mortality

risk

Life: Catastrophe

risk sub-module

Operational risk

Counterparty risk

1 1 1 1

2

1

2

1

0

© 2011 KPMG LLP, a UK limited liability

partnership, is a subsidiary of KPMG Europe LLP and a member firm of the KPMG

network of independent member firms affiliated

with KPMG International Cooperative, a Swiss entity.

All rights reserved.


4.4 Solvency Capital Requirement – Standard Formula To calculate the SCR under the Standard Formula, companies have to perform stresses under market risk, life risk, operational risk, counterparty risk, health risk and non-life risk. We asked insurance companies which stresses they found the most challenging to model. We had 28 companies responding to this question which include some companies who are proposing to use an Internal Model to calculate their Solvency Capital Requirement.

4.4.1 Risk modules

Table 4.1: Most challenging stresses to model in the Asset Liability Models

RISk MOdULE NUMBER OF RESPONdENTS

Market: Interest rate risk 9

Market: Equity risk 2

Market: Property risk 1

Market: Spread risk 8

Market: Currency risk 3

Market: Concentration risk 7

Market: Illiquidity premium risk 4

Life: Mortality risk -

Life: Longevity risk 2

Life: Disability / morbidity risk 3

Life: Lapse risk 8

Life: Expense risk 1

Life: Revision risk 12 -

Life: Catastrophe risk sub-module 1

Operational risk 2

Counterparty risk 15

Health SLT: Mortality risk -

Health SLT: Longevity risk -

Health SLT: Disability / morbidity risk 1

Health SLT: Lapse risk -

Health SLT: Expense risk -

Health SLT: Revision risk -

Health Non-SLT: Lapse risk -

Health Non-SLT: Premium and reserve risk -

Health: Catastrophe risk sub module 2

Non-life: Premium and reserve risk -

Non-life: Reserve risk -

Non-life: Catastrophe risk 1



4. 4.1.1 Market risk The market risk module includes interest rate, equity, property, spread, concentration, currency and illiquidity premium stresses (proposed to be changed to a combination of matching premium and counter-cyclical premium).

Respondents indicated that they find the interest rate, spread and concentration risk to be one of the most challenging stresses to model in their Asset Liability Models. For these risks, more than 25 percent of the respondents indicated that they found them as one of the most challenging stresses to model. Interestingly, two respondents indicated that they found the equity stress one of the most challenging stress to model.

Graph 4.1: Most challenging risk to model – Market risks

Market: Interest rate risk

Market: Equity risk

Market: Property risk

Market: Spread risk

Market: Currency risk

Market: Concentration risk

Market: Illiquidity premium risk

9

2

8

1

3

7

4

0 2 4 6 8 10

4.4.1.2 Life risk Under the lapse risk module, companies are required to perform three separate stresses namely a permanent increase in lapse rates, a permanent decrease in lapse rates and a mass lapse and then use the stress that produces the most onerous capital requirements.

Under the permanent increase / decrease in lapse rates stresses, only those policies that will result in an increase in Best Estimate Liabilities should be included in the lapse stress. Respondents indicated that the lapse risk was also one of the most challenging risks to model.

Graph 4.2: Most challenging risk to model – Life risks

Life: Mortality risk

Life: Longevity risk

Life: Disability / morbidity risk

Life: Lapse risk

Life: Expense risk

Life: Revision risk

Life: Catastrophe risk sub-module

0 2 4 6 8 10

2

1

1

3

0

0

8



4.4.1.3 Operational risk Under the standard formula, the capital requirement for operational risk is calculated using a simple linear formula, based on premiums earned technical provisions and expenses incurred. Surprisingly, two respondents indicated that this is one of the most challenging areas to model.

4.4.1.4 Counterparty risk The counterparty risk stress proved to be the most common risk that respondents found as one of the most challenging risk to model with more than half of the respondents. This is not unexpected, given the relatively higher level of computation involved to calculate the capital requirements under this stress.

4.4.2 difficulties in the calculation of the SCR under the Standard Formula The calculation of the SCR under the Standard Formula involves a number of steps in addition to performing the stresses. We asked companies about the areas where they experienced the most difficulties besides performing the stresses.

Of the 31 respondents to this question, 35 percent indicated that this was the Expected Profits in future premiums, 26 percent indicate that this was the loss absorbency of discretionary benefits and deferred tax, 23 percent indicated that this was on contract boundaries and 16 percent indicated that this was on intergroup transactions and reinsurance. 32 percent of respondents indicated other areas of difficulty.

Graph 4.3: Main difficulties in the calculation of the SCR under the Standard Formula

11

8 8

5

7

10

12

8

4

0 Expected Loss Life: Intergroup Contract Other

profits in future premiums

absorbency capacity of

discretionary

Mortality risk

transactions and

reinsurance

boundaries

benefits


© 2011 KPMG LLP, a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member firm of the KPMG network of independent member firms affiliated w

pofm

ith KPMG International


4.4.3 Granularity level of lapse stress We then asked respondents about the granularity level they are using to determine the most onerous direction of the lapse stress. All respondents answered this question and 47 percent of the respondents indicated that they would determine the direction of the most onerous stress at the product group level. Twenty-five percent of the respondents indicated that this would be performed at the modelling class level whilst 13 percent indicated that this would be performed at the individual policy level.

Graph 4.4: Granularity level of the lapse stress

47%

25%

13% 3%

3%

6% 3%

Individual policy level

Modelling class level

Product group level

Fund level

Company level

Other

Undecided



artnership, is a subsidiary KPMG Europe LLP and a ember firm of the KPMG network of independent member firms affiliated




4.4.4 Management actions When calculating the SCR, companies are able to make assumptions on future management actions. We asked companies which future management actions are allowed for in the calculation of their SCR. There were 30 companies which provided an answer to this question of which 11 indicated that they do not allow for any future management actions in the calculation of their SCR whilst 19 companies indicated that they allowed for at least one management action in the calculation of their Solvency Capital Requirement.

We analysed the companies’ responses separately for realistic and regulatory companies. For those realistic companies that allow for future management actions, a variety of approaches have been adopted, the most popular being adjustments to MVAs, changes to bonus rates and equity backing ratios. This is a similar picture to what we have seen for the management actions allowed in the Technical Provisions.


Graph 4.5: Management actions used in the calculation of the SCR under the Standard Formula – Realistic reporters

Adjustments to MVAs









Changes to defined benefit pension scheme



Other


0 2 4 6 8 10

1

1

1

2

6

4

1

1

1

8

9

9

8

3



The most popular management actions for regulatory reporters were changes in bonus rates. However, these responses were from companies who had less than £500m of with-profits liabilities, and hence exempt from reporting under Pillar 1 Peak 2.

Excluding the responses from the above regulatory reporters, the most popular responses were increases in charges for insurance benefits and increases in administration charges. There were also respondents who indicated that they would change their employer’s contribution rate to their Defined Contribution scheme, reduction in overall expenses and increase in unit-linked fund-related charges.

Graph 4.6: Management actions used in the calculation of the SCR under the Standard Formula – Regulatory reporters

2 4 6 8 10

8

9

9

8

1

1

1

4

6

2

1

1

1

2


Other












Adjustments to MVAs

0

9 Regulatory reporters used changes in regular bonus rates as a management action in their Standard Formula calculations



4.5 Solvency Capital Requirement – Internal Model Companies may use an Internal Model or Partial Internal Model to calculate their SCR. Such Internal Model or Partial Internal Model will, however, be subject to the approval of the FSA and will have to fulfil the requirements set out in Articles 120 to 125 of the EU Directive, namely the Use Test, the Statistical Quality Standards, the Calibration Standards, the Profit and Loss Attribution, the Validation Standards and the Documentation Standards.

4.5.1 Progress There were 19 respondents who indicated that they are using either an Internal Model or a Partial Internal Model and we asked them about the progress on their development of their Internal Model. One respondent did not provide an answer to this question but of the 18 respondents who answered this question, 83 percent indicated that they were on track.

Graph 5.1: Progress on the development of the Internal Model

83%

17%

Behind plan

On track with plan




4.5.2 Challenges We were interested in the main challenges faced by the respondents in the use of their Internal Model. We received a mixed response to this question with the Technical Build of the model most commonly quoted as being the main challenge. 21 percent of the respondents indicated that they found documentation to be the main challenge. This echoes the message in section 4.1.8, where respondents indicated that documentation was an area of difficulty in the implementation of Solvency II. There were three respondents who selected other in the options given to this question. These respondents have commented that more than one of the options given represented the main challenges to the use of their Internal Model.

Graph 5.2: Challenges on the use of an Internal Model

16% 21%

32%

5%

5%

16%

5%


Documentation standards

Complying with the Use test

Interaction with the regulator

Timescales

Lack of management buy-in

Technical build

Other


partnership, is a subsidiary of KPMG

Europe LLP and a member firm of the KPMG network

of independent member firms affiliated with KPMG International Cooperative,

a Swiss entity. All rights reserved.


4.5.3 Internal Model Application Process (IMAP) The IMAP is the process through which the FSA will approve a company’s Internal Model and this involves a pre-application phase where insurance companies are required to submit a pre-application qualifying criteria (PAQC) document to the FSA. Companies are also required to complete and submit a self-assessment template to the FSA.

The FSA required companies seeking a ‘day one’ decision on their internal model to submit their PAQC document by the end of February 2011 and we were interested to see when most companies had submitted their PACQ. The majority of companies indicated that they submitted their PACQ document during the third quarter of 2010.

Graph 5.3: Submission of the PACQ

8

7

6

5

4

3

2

1

0 2010 Q1 2010 Q2 2010 Q3 2010 Q4 2011 Q1

1

4

8

4

1

We also asked respondents whether they had already submitted their first self-assessment template to the FSA. It was interesting to observe that out of the 19 respondents, three respondents indicated that they still had not submitted their first self-assessment template to the FSA.

Graph 5.4: Submission of first self-assessment template

84%

16%

Yes

No



The FSA announced in April this year that it was taking a two-tiered approach in its review of the insurance companies Internal Model. Insurance companies have been categorised as either Tier 1 or Tier 2, based broadly on their size. Tier 1 companies will receive the greatest intensity of review from the FSA throughout the pre-application phase, whilst Tier 2 companies will receive a reduced level of engagement from the FSA.

Forty-two percent of our respondents have indicated that they fall in the Tier 1 category with the rest falling in the Tier 2 category.

Graph 5.5:Tier 1 or Tier 2 category

58%

42%

Tier 1

Tier 2

4.5.4 External validation of Internal Model We asked respondents whether they had plan to have their Internal Model externally validated or reviewed before submitting it for approval to the FSA and all but one out of the 19 respondents confirmed that they would.

Graph 5.6: Plan to have external validation of the Internal Model prior to submission to the FSA

95%

5% Yes

No




4.5.5 Comparison with the Standard Formula One of the requirements for using an Internal Model is that the resulting SCR reflects more appropriately the risk profile of a company. Respondents were asked to indicate how they expect the SCR under their Internal Model to compare with the SCR under the Standard Formula.

We observed a mixed number of responses with an equal number of respondents expecting the SCR to either significantly increase, decrease or remain roughly the same. The majority indicated that they expected a slight decrease in their capital requirements.

Graph 5.7: SCR under IM compared to SCR under SF

22%

17% 17%

27%

17%

Significantly increase capital requirement

Slightly increase capital requirement

Capital requirement to remain roughly the same Slightly decrease capital

requirement Significantly decrease capital

requirement



Respondents were also asked whether they were planning to model any additional risks to those covered under the Standard Formula to which 15 out of the 19 respondents responded affirmatively.

Out of the 15 respondents who are planning to model additional risks not covered under Standard Formula, 60 percent indicated that they would model volatility risks on equity, property or interest rate. The next more common risk modelled is the risk of the company’s own pension scheme.

Graph 5.8:Additional risks modelled in Internal Model, not covered under the Standard Formula

Pension scheme

Equity, property and interest rate volatility

Legislation

Inflation

New business

Other demographic

Shape of yield curve

Group

Other

4

9

1

3

3

3

1

1

2

0 2 4 6 8 10

4.5.6 development of the IM We asked respondents about the development of their Internal Model. 44 percent indicated that they are developing new models whilst 56 percent indicated that they were enhancing either their ICA or Economic Capital models.

Graph 5.9: development of Internal Model

17%

44%

39%

Develop new models

Enhance Individual Capital Assessment models

Enhance economic capital models



4.5.6.1 Replicating portfolios and curve fitting To calculate the capital requirements for a particular risk module under an Internal Model, companies can derive a full probability distribution of net assets by generating a large number of economic scenarios or they can use lite models such as curve fitting or replicating portfolios to approximate the probability distribution.

We were interested in whether companies were using replicating portfolios and curve fitting in their Internal Model. Of the 19 respondents to this question, 32 percent indicated that they were using curve fitting, 21 percent indicated that they were using both and 5 percent indicated that they were using replicating portfolios. A notable 32 percent of respondents indicated that they were not using either.

Graph 5.10: Replicating portfolios and curve fitting

21%

31%

11%

32%

5%

Both replicating portfolios and curve fitting

Curve fitting

Replicating portfolios

Neither

Undecided

21% of respondents use both replicating portfolios and curve fitting to calculate their capital requirements



4.5.6.2 Aggregation of risks and diversification The majority of insurance companies are using a Correlation Matrix to aggregate their risks under the ICA (TPS 2010). Under the Standard Formula, the capital requirements under each risk module are aggregated using a specified correlation matrix to calculate the SCR. We asked respondents about the approach they were planning to use to aggregate their risks under the Internal Model.

It was interesting to observe that ten of the 19 respondents (53 percent) are planning to use copulas with Monte Carlo Simulation which is a notable shift from what we observed under the ICA, where an overwhelming majority of respondents to our 2010 survey indicated that they were still using a Correlation Matrix. The proportion of respondents planning to use a correlation matrix was 37 percent. There were no companies who were planning to use Risk Geographies.

One respondent indicated that it was using a combination of the Monte Carlo Simulation and Correlation Matrix.

Graph 5.11:Approach to aggregation of risks under the Internal Model

5%

53%

5%

37%

Copulas with Monte Carlo Simulation

Correlation Matrix

Undecided

Other

53% of companies are planning to use Copulas with Monte Carlo simulation in their aggregation of risks



4.5.6.3 Asset Liability Models in scope of Internal Model We asked respondents whether their Asset Liability Models were in scope of their Internal Model and 42 percent responded affirmatively which is quite interesting, given there is a general push by firms to narrow down their Internal Model scope.

Graph 5.12:Asset Liability Models in scope of Internal Model

42%

58%

Yes

No

4.5.6.4 Calibration of Internal Model We also asked respondents on the frequency they intend to calibrate their Internal Model. Forty-seven percent of the respondents indicated that they intend to calibrate their Internal Model on a quarterly basis whilst 26 percent indicated they intend to this annually.

Graph 5.13: Frequency of calibration of Internal Model

11%

47%

11%

5%

26%

Quarterly

Half yearly

Annually

Undecided

Other



4.5.7 Granularity of life underwriting risk stresses When performing the mortality / longevity stresses under the Standard Formula, this should only be applied to those insurance policies for which an increase in mortality rates leads to an increase in Technical Provisions.

We asked respondents at which level they applied their mortality / longevity stress. Given that the requirement under the Standard Formula is at a policy level, it was rather surprising that only one respondent indicated that it was applying its stress at a policy level on the longevity stress.

Interestingly, the majority of respondents indicated that they apply the stress at a product level, whilst five out of the 19 respondents indicated that they apply the stress to their whole book.

Graph 5.14: Granularity level of mortality and longevity stresses

Whole book Only where Only where Undecided Other Not applicable more onerous more onerous at a product at a policy

level level

Mortality Longevity

5 5

9

10

1 1 1 1

3

2

10

5

0

26% of Internal Model respondents apply their life stresses at the whole book level



We then asked respondents about the level they were intending to determine which direction is the most onerous lapse stress. Again, the majority of respondents indicated that they are doing this at the product group level. Twenty-five percent of the respondents indicated that they are doing it at modelling class level, whilst 15 percent of respondents indicated they are doing it at company level.

Graph 5.15: Granularity of lapse stress

40%

15%

25%

10% 5% 5%

Individual policy level

Modelling class level

Product group level

Fund level

Company level

Other

4.5.8 dry runs on Internal Model We then asked respondents about their plans to start performing dry runs with their Internal Model. Of the 18 respondents who responded to this question, six have already started and the rest are all planning to start by Q1 2012. Eleven are planning to start either on the last quarter of 2011 or the first quarter of 2012.

Graph 5.16: Plans to start dry runs on Internal Model

6

1

5

6 6

3

0 Already Q3 2011 Q4 2011 Q1 2012 started



4.5.9 Management actions Similar to the calculation of the Solvency Capital Requirement under the Standard Formula, we asked companies about the future management actions they are allowing in the calculation of their Solvency Capital Requirement under their Internal Mode. Only one of the 16 respondents indicated that they do not allow for any future management actions in the calculation of their SCR.

For those companies that allow for future management actions, a variety of approaches have been adopted, the most popular being adjustments to MVAs, changes to bonus rates and equity backing ratios which again is a similar picture to what we have seen for the management actions allowed in the Technical Provisions and the calculation of the Solvency Capital Requirement under the Standard Formula.


Graph 5.17: Management actions used in the calculation of the SCR under the Internal Model – Realistic Reporters

Adjustments to MVAs






Removal of miscellaneous / planned enhancements



Other

0 2 4 6 8

7

7

7

6

1

5

6

1

2

1

7 realistic reporters used changes in regular bonus rates as a management action in their Internal Model calculations



For the regulatory reporters, the most popular management action was a change in new business level. Other respondents indicated that they would change their bond rating category, do credit derisking or increase their unit linked fund charges.

Graph 5.18: Management actions used in the calculation of the SCR under the Internal Model – Regulatory Reporters

Adjustments to MVAs










Other


0 1 2 3

2

1

1

2

1

1

4

1

1

2

3

1

4




We summarised the management actions that companies indicated they were using when calculating their Technical Provisions and their Solvency Capital Requirement. This show that adjustments to MVAs, changes to bonus rates and equity backing ratios are the most popular management actions taken.

Graph 5.19: Management actions used in the calculation of the SCR under the Internal Model, Standard Formula and Best Estimate Liabilities

Adjustments to MVAs









Removal of miscellaneous / planned enhancements





Other


12

10

9

12

13

14

13

8

8

9

10

8

5

4

1

5

4

2

4

2

4

1

1

3

2

2

5

5

5

6

6

2

4

4

2

3

2

2

2

5

4

1

11

14

8

3 6 9 12 15

0

0

0

0


Solvency Capital Requirement - Standard Formula

Solvency Capital Requirement - Internal Model



4.5.10 Meeting the Internal Model tests Insurance companies which use an Internal Model to calculate their SCR have to develop an Internal Model that fulfil the requirements of the Use Test, the Statistical Quality Standards (including Data Quality), the Calibration Standards, the Profit and Loss, the Validation Standards and the Documentation Standards. The Internal Model also has to fulfil the requirements of the Model Governance and the External Models and Data.

We were interested in the overall readiness of the companies in the above areas.

Graph 5.20: Readiness of Internal Model

Use Test

Data Quality

Calibration

P&L Attrition

Validation

Documentation

Model

External Models

17% 67% 17%

24% 76%

6% 28% 67%

11% 22% 67%

17% 28% 56%

22% 17% 61%

11% 28% 61%

6% 44% 50%

0% 20% 40% 60% 80% 100%

Significant work required

Some work required

Almost at required standard

22% of Internal Model respondents believe significant work is required to meet the Internal Model documentation standards




of KPMG Europe LLP and a member firm of the KPMG network

of independent member firms affiliated with KPMG International



We were also interested in the companies’ progress on the development of their documentation of their Internal Model. Sixty-three percent of the respondents indicated that they were at a reasonably advanced level, whilst 27 percent indicated that they were still at the early stages. It was surprising to note that five percent of the respondents had still not considered the documentation of their Internal Model.

Graph 5.21: Progress on the development of the documentation of the Internal Model

63%

27%

5%5% Very far advanced

Reasonably far advanced

Still in early stages

Not yet considered


4.5.10.1 Use Test We asked respondents about the frequency at which the SCR numbers will be shared with senior management. Of the 19 respondents to this question, 14 indicated that the SCR numbers will be shared on a monthly basis.

Graph 5.22: Frequency at which SCR numbers will be shared with senior management

14

2 2 1

14

7

0 Monthly Quarterly Half yearly Undecided

We were also interested whether remuneration was linked to the Internal Model results. We observed that the majority of respondents were still undecided. However, seven out of the 19 respondents indicated that they would link remuneration to the Internal Model results which should aid compliance with the Use Test.

Graph 5.23: Linking of remuneration to the Internal Model results

53%

37%

10%

Yes

No

Undecided

© 2011 KPMG LLP, a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member firm of the KPMG network of independent member firms affiliated with KPMG InternationCooperative, a Swiss entity. All rights reserved.

al


Graph 5.24: development of an Economic Profitability measure

21%

63%16%

Yes

No

Undecided

4.5.10.2 Profit and Loss AttributionOne of the requirements for an Internal Model to gain FSA approval is for companies to perform a Profit and Loss Attribution which involves reviewing at least annually the causes and sources of profits and losses for each major business unit.

We were interested in whether respondents were developing an economic profitability measure. Of the 19 respondents to this question, 63 percent indicated that they are developing their own economic profitability measure and 37 percent indicated that they were not developing an economic profitability measure or were still undecided.

We asked respondents how their Profit and Loss Attribution fit in their validation policy. Seventy-six percent of the 17 respondents indicated that it is a key tool of the validation process.

Graph 5.25: Profit and Loss Attribution and validation policy

12%

12%

76%

Key tool of the validation process

P&L still under development

Undecided



Companies are also required to demonstrate how the categorisation of risk chosen in their Internal Model explains the causes and sources of profits and losses.

We also asked respondents about the risk categorisations in their Profit and Loss Attribution and the risks modelled in their Internal Model. Out of the 18 respondents to this question, only 61 percent indicated that they were using the same risk categorisation in their Internal Model.

Graph 5.26: Same risk categorisation used in the Internal Model and Profit and Loss Attribution

28%

11%

61%

Yes

No

Undecided

The EU Directive does not set out a definition of the profit and loss that should be used for the purpose of performing the profit and loss attribution. We were interested in which items of the balance sheet would the Profit and Loss Attribution performed by companies cover. It was surprising to note that not all respondents included the Best Estimate Liabilities, the Solvency Capital Requirement and the Assets in their responses. Out of the 19 respondents to this question, only 42 percent and 58 percent indicated that Risk Margin and Own funds will respectively be included in the Profit and Loss Attribution.

Graph 5.27: Items covered by Profit and Loss Attribution

74%

42%

26%

58%

58% 42%


Risk Margin

Solvency Capital Requirement

95%5%Minimum Capital Requirement

37%

42%

63%

58%

Assets

Own funds (including tiering)

0% 20% 40% 60% 80% 100%

Yes No



As noted, the Profit and Loss Attribution is required to be performed at least annually under Solvency II. We asked respondents about the timing of their Profit and Loss Attribution.

Out of the 19 respondents to this question, 21 percent indicated that they will review the causes and sources of their surplus on an annual basis whilst 37 percent indicated that they will do this on a quarterly basis. Thirty-two percent of the respondents had still not decided how frequently they would perform their Profit and Loss Attribution. One respondent indicated that it would perform a Profit and Loss Attribution whenever a full model run would be done.

Graph 5.28:Timing of Profit and Loss Attribution

32%

5%

16%

5%

26% 5%

Annually outside the timing of the Quantitative

Reporting Template Annually within the

timing of the Quantitative Reporting Template

Quarterly outside the timing of the Quantitative

Reporting Template

Quarterly within the 11% timing of the Quantitative

Reporting Template

Monthly

Other

Undecided

4.5.10.3 Validation Before companies can use their Internal Model to calculate their SCR, they have to submit an application to the FSA and one of the requirements to gain FSA approval is to perform a validation of the Internal Model and produce a report setting out the validation of the Internal Model and the results produced by the Internal Model. The validation process will also need to be carried out on a regular basis. The validation of the Internal Model can be seen as the evidence of how the Internal Model complies with the other Internal Model requirements.

We were interested in the respondents’ validation team and how they fit in the “Three lines of defence model”. Given the validation of the Internal Model has to be an independent process, it was surprising to see that out of the 18 respondents to this question, half indicated that their validation team belonged to the Production team. The other half indicated that the validation team belonged to the Risk Function.

We then asked respondents who was responsible in carrying out the Internal Model validation and preparing the Internal Model validation report. Again, we were surprised to note that 33 percent and 26 percent of the respondents indicated that the Production team was responsible for carrying out the Internal Model validation and preparing the Internal Model validation report respectively.



Graph 5.29:Attribution of responsibility of the validation tasks

Who is responsible for carrying out IM validation

To which function does you IM validation team belong

Who is responsible for preparing IM validation report

33% 67%

50% 50%

26% 68% 5%

0% 20% 40% 60% 80% 100%

Production team (1st line)

Risk function (2nd line)

Internal audit (3rd line)

We also asked respondents whether they had a separate Internal Model validation team to which an overwhelming majority responded affirmatively.

We then asked respondents about the timing of the validation within the reporting cycle. Eight respondents indicated that they were planning to do this annually whilst five indicated that they were planning to do this on a quarterly basis.

Graph 5.30:Timing of validation

Quarterly within the timing of the Quantitative Reporting Templates

Quarterly outside the timing of the Quantitative Reporting Templates

Annually within the timing or the Quantitative Reporting Templates

Annually outside the timing of the Quantitative Reporting Templates

Other

0 2 4 6

6

3

2

4

4


b endent member firms affiliated with KPMG International


4.5.11 External models and data Article 126 of the EU Directive specifies that the use of a model or data obtained from a third party shall not be considered to be a justification for exemption from any of the requirements for the Internal Model.

We were interested in the external models that are being used by respondents. Out of the 19 respondents, 16 percent indicated that they are not using any external model. The majority of respondents indicated that they were using an Economic Scenario Generator provided by a third party. Two respondents indicated that their calculation kernel is provided by a third party. Other respondents indicated that they are using other external models than the options available in the survey, including operational risk, credit risk and catastrophe risk.

Graph 5.31: Use of External models

57%

16% 16%

11%

Do not use external models

Calculation Kernel provided by third party

Economic Scenario Generators provided by a

third party

Other

4.5.12 Equity stress dampener We also asked respondents about their plan to use an equity stress dampener in their Internal Model. We observed a mixed response to this question with almost a quarter of respondents indicating that they were still undecided whilst the remaining respondents were equally divided between using a dampener and not using one.

Graph 5.32: Use of equity stress dampener in Internal Model

Yes

No

Undecided

© 2011 KPMG LLP, a UK limited liability partnership, is a subsidiary of KPMG Europe LLP er firm of the KPMG network of indepCooperative, a Swiss entity. All rights reserved.

and a mem

26%

37%

37%

© 2011 KPMG LLP, a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member firm of the

KPMG network of independent member firms affiliated with KPMG International Cooperative, a Swiss entity.



4.6 Pillars 2 and 3 Pillar 2 sets out the requirements in relation to risk management, processes and procedures, the key functions together with the Own Risk and Solvency Assessment (ORSA) and capital management requirements. While many of the Pillar 2 concepts, ideas and practices are not all entirely new concepts, under Solvency II the Pillar 2 requirements must be well-integrated and clearly tie various aspects of the ongoing governance of business to risk and capital management.

Pillar 3 focuses on market discipline, transparency and disclosure requirements, both publicly and direct submissions to the Regulator (the FSA for firms who write business in the UK). In turn the Regulator will use this information to maintain and develop its supervision such that the supervision is effective and proportionate, based on individual risk profiles.

4.6.1 Pillar 2 and 3 actuarial involvement It is clear from our survey that very few companies’ actuarial functions have full ownership of these areas, with the vast majority having only partial involvement.

As can be observed from the graphs above, the actuarial functions’ involvement is limited. For the ORSA assessment, around 25 percent of actuarial functions have full ownership; for other aspects the figures are significantly lower.

Although the amount of entire ownership is low for these Solvency II requirements, it is interesting to see that there is actuarial input across the whole of both Pillars for 90 percent of respondents. We also note that by avoiding full ownership across all areas, companies are continuing to be in line with the “three lines of defence” philosophy behind Solvency II.

Graph 6.1: Level of actuarial function involvement in Pillars 2 and 3

30

25

20

15

10

5

0

8

23

29 27

1 1 2 2 3

Own Risk and Solvency Pillar 2 excluding Own Risk Pillar 3 Assessment and Solvency Assessment

Entire ownership

Partial involvement

No involvement



4.6.2 ORSA risks covered versus those covered under SCR The ORSA may well include aspects to reflect how the long term risk profile of each business deviates from the assumptions underlying the SCR (for both Standard Formula and Internal Model). Companies may choose not to assess only the current risks but also the risks faced in the long term. Long term projections of the business which are a key part of any firm’s financial planning, such as business plans, could feed into the ORSA in order to enable the undertaking to form an opinion on the future overall solvency needs and own funds.

Therefore we anticipate that some business would include other risks not captured by their SCR calculations. We asked whether companies are including risks in their ORSA which are not currently captured by the SCR. A large majority (around 60 percent) of respondents indicated that they were.

Amongst the risks identified, the following risks were predominantly noted:

• Strategic

• Reputational

• Pension Scheme

• Projection mechanism/periods for new business

• Liquidity, Sovereign and Bank exposure

• Dividend stream

Graph 6.2:Are there risks captured under ORSA but not SCR?

No

Yes

2

6

4

3

7

8

0 1 2 3 4 5 6 7 8

Partial Internal Model

Full Internal Model

Standard Formula




4.6.3 Solvency Position comparison with ORSA 4.6.3.1 Frequency of comparison The expectation under Solvency II is that the ORSA must be taken into account on an ongoing basis for strategic decision-making. With that in mind, we asked companies how frequently they expected to measure their solvency position against the ORSA.

The most common intended frequency was quarterly (40 percent), followed by annually (32 percent), with a minority being half yearly. However a reasonable proportion (around 16 percent) of companies are expecting to carry out this assessment at other intervals, including monthly, at least annually and on a systematic ad hoc basis.

Graph 6.3: Frequency of assessment of solvency position under ORSA

15

12

9

6

3

0

13

3

10

2 3

Quarterly Half yearly Annually Monthly Other

© 2011 KPMG LLP, a UK limited liability partnership, is a subsidiary of KPMG

Europe LLP and a member firm of the KPMG network of independent member firms affiliated with KPMG

International Cooperative, a Swiss entity. All rights reserved.


4.6.3.2 Formal ORSA reporting We then asked how frequently this assessment would be likely to result in a formal ORSA report. Although 40 percent of respondents would assess their Solvency position against their ORSA quarterly, only one would produce a formal report at this frequency. It is clear that the vast majority (90 percent) expect to produce formal ORSA reports annually following comparison of their ORSA and solvency positions. The respondent who answered differently claimed that ORSA would be assessed on an annual basis at the least.

Graph 6.4: Expected frequency of preparation of a formal ORSA report following ORSA vs Solvency position assessment

1 2

28

Annually

Half yearly

Quarterly

10% of respondents will produce formal ORSA reports more frequently than annually



4.6.4 Creation of separate specialist ORSA teams We asked whether companies were planning to create separate teams when Solvency II goes live, with the teams being responsible for running and co-ordinating the ORSA.

The majority (68 percent) of companies were not planning to create new separate ORSA teams for this purpose, although 29 percent were undecided.

Graph 6.5:Are companies expected to set up a separate dedicated ORSA team?

1

9

21

Yes

No

Undecided

4.6.5 Responsibility for preparing ORSA We asked which function would be performing the ORSA. The most common response by far was the Risk function (58 percent), followed by the Actuarial function (26 percent), and then the Finance function. The other respondents indicated that it would be a mixture of Risk and Actuarial functions that would be conducting the ORSA.

Graph 6.6:Who is likely to be performing the ORSA?

8

3

18

2

20

15

10

5

0 Actuarial function Finance function Risk function Other



4.6.6 Projection period for ORSA The ORSA is defined as the entirety of the processes and procedures employed to manage the short and long term risks companies face (or may face) and to determine the own funds necessary to ensure that the overall solvency needs are met at all times. With that in mind, offices have the ability to dictate the projection period used for their ORSA.

We asked how long the projection period was likely to be for companies’ ORSA. The most common periods were both three years and under and four to five years with 42 percent opting for each of these periods. A minority (16 percent) of respondents expected to have a projection period at or in excess of five years.

Graph 6.7: Length of projection period for the ORSA

15

12

9

6

3

0

13 13

5

3 years or less 4 or 5 years More than 5 years

4.6.7Timing for first ORSA We asked companies when they expected to carry out their first ORSA. It is pleasing to see that over half (55 percent) of the respondents are either in the process of or are intending to carry out their first assessment by the end of this year. The most frequent (29 percent) expected timing was Q4 2011.

Graph 6.8: Expected date for carrying out first ORSA

10

8

6

4

2

0

6

2

9

3

6

3

1 1

Already Q3 Q4 Q1 Q2 Q3 Q4 Later than started 2011 2011 2012 2012 2012 2012 Q4 2012



4.6.8 Progress to date for Pillar 2 and 3 requirements We asked companies to indicate how far they had progressed in several key aspects of Pillar 2 and Pillar 3. The first major focus of EIOPA was the Pillar 1 aspects of the market, and there has been a lot more activity on Pillar 1 than there has on Pillar 2 and Pillar 3. We anticipate that over the next few months firms will be moving their attention from some of the Pillar 1 aspects of the regime to the Pillar 2 aspects, and then through to the Pillar 3.

Overall, most participants seem to have progressed well in the areas of governance and risk management / identification. Areas where significant work is still required include internal reporting requirements, external reporting and ORSA.

It was interesting to note that very few companies believe that they are at the required standard in these key areas.

Graph 6.9: Progress in key Pillar 2 and 3 aspects

44% 53% 3%Risk management and identification

56% 44%

34% 63%3%

External reporting

Internal reporting

6% 13% 72% 9%

41% 50% 9%

Governance

Own Risk and Solvency Assessment

0% 20% 40% 60% 80% 100%

Significant work required Almost at required standard

Some work required At required standard

41%of respondents believe there is significant work required for their Own Risk and Solvency Assessment



4.6.9 Reporting efficiency initiatives A key driver behind Pillar 3 is the wish for increased transparency across the Insurance industry, captured by the annual requirement on firms to publicly disclose their Solvency and Financial Condition Report (SFCR) and to quarterly submit to their regulators their Quantitative Reporting Templates (QRT). Whilst the format is not finalised these reports will probably be more detailed and granular than existing reporting requirements in Europe.

We asked companies to indicate what mechanisms they were adopting in order to speed up their existing quarterly and annual reporting processes in order to achieve the deadlines required for Solvency II reporting.

Across both quarterly and annual reporting, the following initiatives were most commonly being adopted:

• Updating all non-economic assumptions before the end of the relevant period

• Minimising model run times

• Not changing stress assumptions unnecessarily

In addition, for quarterly reporting not changing the correlation matrix was also a very popular initiative.

Graph 6.10: Efficiency initiatives to speed up reporting

Increased use of estimation and approximation

Only running a limited number of scenarios

Minimising the amount of analysis of movements work

Reducing the number of simulations used in the model

Minimising model run times

Rolling forward the non-linearity adjustment from an earlier period

If fitting curves / replicating portfolios: not updating this from prior period

If fitting curves / replicating portfolios: do this off cycle

Not changing the correlation matrix

Not changing stress assumptions unless necessary

Updating all non-economic assumptions before year end

Updating non-modelled items off cycle

Rolling forward data/results from an earlier month end

0 5 10 15 20 25

2 8

21 19

2 5

5 6

8 18

12 7

23 19

9 10

6 9

1

2 2

1

1

0

0

6

Annual reporting Quarterly reporting



4.6.10 Frequency of hard closes One option that has been used by firms to help improve the accuracy of their reporting process has been to increase the frequency of the account hard closes. A hard close is when a company performs its full valuation process, as at the valuation date. This is the alternative to approximate “roll forwards”, although many companies will opt to do both.

We asked companies to indicate whether they were increasing the frequency of their account hard closes as a result of the new reporting standards.

Of the 32 respondents, eight signalled that they did intend to increase the frequency of their hard closes. Just over half (56 percent) of respondents were not intending to increase the frequency, whereas 19 percent were undecided.

Graph 6.11: Are you increasing the frequency of hard closes?

68

18

Yes

No

Undecided

25%of respondents will be increasing the frequency of hard closes




4.6.11 key issues hitting SII reporting cycles We asked companies to indicate the main issues impacting their Solvency II reporting cycles. The most common issue was achieving sign off (47 percent of responses) followed by calculating their SCR (31 percent of responses). Those that responded with other issues highlighted key points such as the more onerous timescales, the production of audited figures before final financial statements are published and issues with validation.

Graph 6.12: Principal issues impacting reporting cycles

Achieving sign-off Producing balance Calculating Solvency Other sheet Capital Requirement

25

20

15

10

5

0

21

14

7

3

4.6.12 Reporting results in Q4 QRTs and SFCRs We asked companies to indicate whether they plan to report different results in their Solvency and Financial Condition report (SFCR), as compared to those submitted in the Q4 Quantitative Reporting Templates (QRT), given the extra time for submission.

No respondents answered yes whereas 25 percent said no, with 75 percent being undecided.








Graph 6.13: different results in annual SFCR and Q4 QRT cycles

8

24

No

Undecided

4.6.13 Commercial implications of external reporting requirementsWe asked companies what the commercial implications were for their insurance business as a result of the public disclosures required in the SFCR as a result of CP58, the EIOPA consultation paper which predominantly detailed the Pillar 3 reporting process.

Just over half (53 percent) viewed the implications to be moderate, with only nine percent viewing the risk as low; another 34 percent had not yet fully assessed the impact of CP58 so were undecided.

Graph 6.14: Commercial implications of SFCR public disclosure requirements

11

17

1

3

Significant – there are a number of commercially

sensitive disclosures required which are currently

not in the public domain

Moderate – there is some information required to be publicly disclosed in the SFCR which we do

not disclosure currently but there is little that is commercially sensitive

Low – there is little required to be publicly disclosed in

the SFCR which we do not disclose currently and none

is commercially sensitive

Not assessed yet




4.6.14 Financials reporting system under Solvency II We asked companies whether their existing financial system was suitable for SII reporting.

A large majority (80 percent) recorded that it would be suitable, subject to some enhancements.

Graph 6.15: Is your existing financial reporting system suitable for SII reporting?

6

24

Yes with some enhancements required

No we need a new system and are implementing it







4.6.15 Systems built for QRT We asked companies whether they had started systems built on Quantitative Reporting Templates as yet.

A very small minority (16 percent) had started, whereas the large majority were either intending to start soon or holding off until there was more stability on QRTs.

Graph 6.16: Have you started systems built on QRT?

15

14 12

12

9

6

5 3

1

0 Yes No, intend to start No, holding off until No, other reason

soon more stability on Quantitative Reporting

Templates

4.6.16 Commencement of dry runs of Quarterly Reporting Templates We asked companies when they planned to start their dry runs of the Quantitative Reporting Templates (QRTs).

As for the last question regarding building systems on QRT, a minority (seven percent) had started, whereas the large majority were either intending to start soon or holding off until there was more stability on QRT requirements. Overall, just over a quarter (27 percent) are expecting to start in 2011, with the vast majority expecting to start in 2012. The most common starting date intended was Q2 2012 with fifty percent of respondents expected to start then.

Graph 6.17: Start date intended for commencement of QRT dry

15

12

9

6

3

0 2 2

4 4

15

2 1

Already Q3 2011 Q4 2011 Q1 2012 Q2 2012 Q3 2012 Q4 2012 started



4.6.17 Preparation for IFRS Phase II reporting Whilst the implementation date for the new IFRS for insurance contracts is not definitive, it looks as though the start date for IFRS Phase II will not be before the start of Solvency II. We asked companies to reflect on their progress in preparation for IFRS II and the general consensus around this was a lack of focus across many different areas. This is highlighted in the analysis below.

We asked companies whether they had started their preparation for reporting under IFRS Phase II.

Well over half of the respondents (59 percent) had not yet commenced preparations with the other 41 percent having made some progress.

Graph 6.18: Have you started preparation for IFRS Phase II?

19

13

Yes

No



4.6.18 Impact of IFRS Phase II on Solvency II IFRS Phase II attempts to move the industry from overly prudent approaches towards a more market consistent basis. Although we can see a similar attitude between this and Solvency II, most companies had not yet proactively sought out opportunities to take advantage of the similarities.

We asked companies how they expected IFRS Phase II would impact their Solvency II programme.

Just under one-third (31 percent) were undecided whereas a similar aggregate number (28 percent) expected that there would either be a significant impact, or IFRS Phase II would be directly incorporated into their SII project.

Graph 6.19:Anticipated impact of IFRS Phase II on SII programme

Other

Undecided

Limited impact

Slight impact

Significant impact

IFRS II will be incorporated directly into the Solvency II project

1

10

5

7

6

3

0 2 4 6 8 10

31% of respondents are undecided on how IFRS Phase II will impact their Solvency II programme




4.6.19 IFRS Accounting from 2013 We asked companies to indicate how they plan to account for insurance business within their IFRS statements when the FSA returns cease at the end of 2012. Note, this question was asked in the context of Solvency II commencing from 1 January 2013. We would expect companies to give an equivalent answer in the context of the Solvency II start date being deferred to 1 January 2014.

The vast majority (91 percent) were undecided, but the lack of guidance on IFRS at the time of writing this report helps explain this figure.

Graph 6.20:Accounting for Insurance Business under IFRS post 2012

30

25

20

15

10

5

0

29

11 1 0

Continue with Solvency II EEV or MCEV Early adopt Phase Undecided MSSB or Solvency II adjusted for II or Quasi adopt

adjusted for residual margin Phase II residual margin



of KPMG Europe LLP and a member firm of the KPMG network of

independent member firms affiliated with KPMG International Cooperative,



4.7 Product PricingIn this section we look at product pricing and Solvency II in terms of Solvency II’s current and potential future impact on product pricing.

4.7.1 Impact of SII on product pricing We asked whether companies had started considering the impact of SII on their pricing of products. The vast majority (81 percent) of companies have started considering the impact on pricing.

Graph 7.1: Considering the impact of SII on pricing

6

25

Yes

No

19% of respondents have not yet considered how Solvency II will reflect on their product pricing



4.7.2 Impact on product prices in practice We asked whether companies had started to reflect the capital requirement implications of Solvency II on product prices.

Just over half (58 percent) of companies have not yet begun to reflect the expected SII capital requirements in pricing. Around 26 percent of companies have started reflecting the SII SCR impact to pricing for part of their business and a further 16 percent are have already reflected the anticipated impact to all of their business.

Graph 7.2: Impact on pricing in practice

5

8

18

Yes, to all of the business

Yes, for part of the business

No

4.7.3 Allowance for diversification in pricing We posed a question to establish the extent to which companies planned to allow for diversification in pricing between the risks for the new policies being sold and the risks for existing business.

Two-thirds of companies were undecided whereas 15 percent said that they did not plan to make any allowance for this potential diversification.




Graph 7.3:Allowance for diversification in pricing between new and existing policies

4

18

3

1

1

No allowance for diversification

Diversification across new business written within

product group

Diversification across new and existing business within

product group

Diversification across new business written in all

product groups

Undecided

© 2011 KPMG LLP, a UK limited liability partnership, is a subsidiary of KPMG

Europe LLP and a member firm of the KPMG network of independent member firms affiliated with KPMG

International Cooperative, a Swiss entity. All rights reserved.


4.7.4 Method selected in allowing for diversification benefit We asked companies which method they had selected in order to allocate diversification benefits.

Most companies were as yet undecided with just under two thirds of companies being in this category. For the minority of companies who have already decided which approach to adopt, there was no clear distinction between the popularity of allocation methods with similar levels of responses for the Euler method, Management Discretion and Marginal Approach.

Graph 7.4: Methods selected in allocating the diversification benefit

3

4

3

18

Euler Method

Marginal approach

Management discretion

Undecided

64% of respondents were undecided on how they would allocate diversification benefits




4.8 Tax

4.8.1 Introduction The tax relief which can be taken on the pre-tax SCR (the loss absorbing capacity of deferred tax) is a key driver of the overall capital requirement under Solvency II. Despite representing such a material potential reduction to the SCR, tax is an area where there remains considerable uncertainty. In particular, tax was dealt with inconsistently by companies across Europe during QIS 5. Regulators are alert to this and are aware of the materiality of the issue. We expect that large tax credits and/or net deferred tax assets will be a particular area of scrutiny for supervisors. Accordingly, companies need to understand the sources and quality of the evidence that support the tax adjustment, particularly where future profits are assumed.

We were particularly interested in the range of methods used to compute the loss absorbing capacity of deferred taxes. The results have been collated and are summarised in the following sections.

© 2011 KPMG LLP, a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member firm of the KPMG network of independent

member firms affiliated with KPMG International Cooperative, a Swiss entity. All rights reserved.


4.8.2 deferred tax4.8.2.1 Extent to which loss absorbing capacity of deferred tax is recognisedThe loss absorbing capacity of deferred tax in the SCR can be thought of as the tax credit which is available to reduce a pre-tax loss. The shock loss gives rise to a potential deferred tax asset. This deferred tax asset can only be valued to the extent there are deferred tax liabilities on the economic balance sheet or there is evidence of future profits.

We were interested to know to what extent companies are recognising the loss absorbing capacity of deferred tax in the SCR. Graph 8.1 sets out the responses to this question. As can be seen, for approximately 55 percent of respondents, the loss absorbency of deferred tax is supported only by the deferred tax liability (DTL) and in some cases the DTL represented a cap on the loss absorbency of deferred taxes. Only six respondents stated they are using an analysis of future income or profits to support the size of the loss absorbing capacity of deferred tax.

Four respondents assume the loss absorbing capacity of deferred tax is nil. This echoes the findings of EIOPA’s QIS5 report of March 2011, which showed that 40 percent of undertakings who took part in QIS5 did not calculate any loss absorbency adjustment. It is clear that there is a strong need for additional technical guidance in this area.

Graph 8.1: Extent to which loss absorbing capacity of deferred tax is recognised

4

7

9

4

2

12 Assumed to be nil

Fully recognised, given the size of the deferred tax

liability on the unstressed balance sheet

Recognised to the extent of the deferred tax liability on

the unstressed balance sheet

Supported by reference to future income or profits and / or prior year income or profits

Supported by reference to future / prior year income or profits, future management

actions and future tax planning

Recognised at the full tax rate but not fully tested

Other



4.8.2.2 Sources of future profits to support deferred tax assets We asked which sources of future income or profits are anticipated when valuing deferred tax assets. This question was not specific to either the stressed or the base balance sheet. Respondents were invited to select all options that apply.

There were 20 respondents to this question. Out of these 20 respondents, two stated that they are undecided and one stated that the question did not apply as it had no deferred tax asset. There were therefore 17 respondents who identified at least one source of future income or profit. Graph 8.2 sets out the responses to this question.

Notably, the three most common sources of income anticipated by respondents are the release of risk margins, allowance for future new business and the investment return on excess capital. One rather striking observation, however, is that none of these sources is being used by more than 56 percent of respondents indicating a divergence of practices.

Graph 8.2: Sources of future profits anticipated when valuing deferred tax assets

Other

Income or profits in excess of the risk free rate

Income or profits from non-insurance entities in group

Markets reverting to mean post-shock

Investment return on excess capital

Future new business

Release of risk margins

0 2 4 6 8 10

3

3

2

2

8

7

9

45% of respondents anticipated the release of risk margins to support deferred tax assets



4.8.2.3 discounting of deferred tax assets and liabilities We were interested in whether respondents discount deferred tax assets and liabilities on their Solvency II balance sheets. As shown in Graph 8.3, respondents are fairly evenly split on this issue, with 55 percent using discounting and 45 percent electing not to discount.

Discounting is not permitted by IAS 12 but failure to discount is inconsistent with the principles of the economic balance sheet. Often deferred tax is calculated on the difference between two discounted numbers which is not inappropriate. However this is not always the case (particularly where there are tax losses). The results imply that companies are aware of the potential distortive effects and may be seeking to find appropriate alternative interpretations.

Graph 8.3: discounting of deferred tax assets and liabilities

13

16

Yes

No

4.8.2.4 Recognition of the deferred tax asset on the stressed balance sheet We were interested in the sources of future profits and income which respondents use to support the deferred tax asset on the stressed balance sheet. There were three questions in the survey which specifically relate to the recognition of the deferred tax asset on the stressed balance sheet.

We asked respondents whether they anticipate the future profits from new business in order to support the deferred tax asset on the stressed balance sheet. Graph 8.4 sets out the responses to this question. Notably, of the 16 respondents who answered either yes or no, there was an even split, with eight anticipating new business and eight not anticipating new business. It is interesting to note that there was no consensus on the number of years of new business which should be included. This suggests that some companies are linking this assumption to their normal business planning cycle, while others are not restricting it in this way.

On the issue of new business, we are aware of arguments both for and against inclusion. On one hand, it may be argued that anticipating future new business is inconsistent with the basic principles of the valuation. However, a counterargument to this is that it is permissible to include some new business for the purpose of recognising deferred tax assets as long as one allows for the capital cost of writing the new business.


© 2011 KPMG LLP, a UK limited liability partnership, is a subsCooperative, a Swiss entity. All rights reserved.

idiary of KPMG Europe LLP and a member firm of the KPMG net© work of independent member firms affiliated with KPMG International


Graph 8.4: New Business as source of future profits

10

3

3

2

8

Yes 1 Year of New Business Only

Yes, between 2 and 5 years of New Business

Yes, more than 5 years of New Business

No

Not applicable

2011 KPMG LLP, a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative, a Swiss entity. All rights reserved.


We further asked whether the release of the Risk Margin is assumed to be a source of future profits. Graph 8.5 sets out the responses to this question. Of the 23 respondents who answered either yes or no, ten stated that they use the release of the risk margin as a source of future profits.

Graph 8.5: Release of Risk Margin as source of future profits

6

13

3

7

Yes, in full

Yes, to the extent there is no double count with the

loss absorbency of Technical Provisions

No

Not applicable (mutual)

We were interested in the type of profit projections which are being used in the case where future income or profits are used to support the deferred tax asset on the stressed balance sheet. We asked respondents to state whether their profit projections are scenario specific. Graph 8.6 sets out the responses to this question. Interestingly, there is an even split between the number of respondents who use future income or profits which are consistent with the position following the single equivalent scenario, and the number of respondents who use base case future income or profits as a proxy.

43% of respondents will use the release of the Risk Margin as a source of future profits



Graph 8.6: Profit projections used for future income

11

7

7

Yes, the future income or profits are consistent with the position following the single equivalent scenario

No, base case future income or profits used as a proxy

Not applicable

4.8.2.5 Simplifications We asked respondents whether they would support a simple flat rate approach to deferred tax recognition if this were to be mandated by the regulator. Graph 8.7 shows the responses to this question. As can be seen, the majority of respondents are undecided. Of those who expressed an opinion, the majority were in favour of a simple flat rate approach.

Graph 8.7: Support for a simple flat rate approach to deferred tax recognition

19

8

2

Yes

No

Undecided



4.8.3 Modelling sophistication The level of sophistication in the tax calculation varies from company to company. We asked respondents to indicate how sophisticated they consider the treatment of tax in their internal model and standard formula SCR to be. Although the responses to this question are subjective, it does give an indication of how respondents rate their tax calculation relative to peers. Graph 8.8 sets out the responses to this question.

Interestingly, 14 respondents consider their level of sophistication to be ‘Low’. Only four companies consider the sophistication to be ‘High’. Out of the small and medium-sized respondents (i.e. those with less than £5bn Peak 1 insurance liabilities), there was not a single respondent which rated its level of sophistication as ‘High’.

The responses to this question were correlated to a certain extent with the results in Graph 8.1. In particular, the four respondents who assume that the loss absorbency of deferred tax is nil each rate their level of sophistication as ‘Low’.

Graph 8.8: Sophistication of tax

14

4

11

High

Medium

Low

4.8.4Tax in internal model 4.8.4.1 Policyholder tax We were interested to know how companies are allowing for tax in their Solvency II internal model.

We asked respondents whether they consider the behaviour of deferred policyholder tax component of the Best Estimate Liabilities under stress. Graph 8.9 sets out the responses to this question. As can be seen, 38 percent of respondents do not consider the behaviour of this component. This is not particularly surprising, as policyholder and shareholder tax will often be calculated in different places and it may be challenging to consider the behaviour of policyholder tax under stress.



Graph 8.9: Consideration of policyholder tax under stress

11

5

13

Yes

No

Not applicable (No material Basic Life Assurance and

General Annuity Business)

4.8.4.2 Shareholder tax in the internal model SCR We asked how shareholder tax is accommodated in the calculation of the internal model SCR. Graph 8.10 sets out the responses to this question, where we have only included those respondents who stated that they plan to use either a full or partial internal model.

Of the 12 respondents who gave a response other than ‘Not applicable’, nearly two thirds stated that the internal model calculated a pre-tax SCR in the first instance and the tax adjustment is a discrete final step.

Graph 8.10:Allowance for shareholder tax in the internal model SCR

4

6

8

The Internal Model performs a tax calculation for each

stochastic run

The Internal Model calculates a pre-tax Solvency Capital

Requirement in the first instance and the tax

adjustment is a discrete tax final step

Not applicable (Mutual)



4.8.4.3 Interactions between policyholder and shareholder tax When companies were asked to provide more information as to how the interactions between policyholder and shareholder tax are allowed for, a range of responses emerged. Graph 8.11 sets out the responses to this question.

For the 16 companies for whom this was applicable, the most common response was that Best Estimate Liabilities are assumed to include any deferred policyholder tax and BLAGAB profits and losses are tax affected independently at an incremental rate (currently six percent). This is not surprising as this method is the traditional method. However, it is important to be aware that there is an implicit assumption made in this method that the company is in an ‘excess I’ (‘XSI’) position. This assumption should be tested with consideration of the post-2012 tax rules and stressed scenarios, as there is a risk that companies may otherwise overstate the tax credit on expenses.

Graph 8.11: Interaction between policyholder and shareholder tax

11

8

2 3

3

Best Estimate Liabilities assumed to include any

policyholder tax, Basic Life Assurance and General

Annuity Business profits and losses tax effected

independently at incremental rate (currently 6%)

Policyholder and shareholder tax dealt with independently

(as above) but with key implicit assumptions on tax

profile considered and/or tested

Policyholder and shareholder tax dealt with independently

(as above) but with results validated by an off-line tax

model

Interactions modelled as part of Internal Model

Not applicable (No material Basic Life Assurance and

General Annuity Business and / or mutual)

4.8.4.4 Consistency with expected post-2012 tax regime We asked whether the tax assumptions in the internal model are consistent with the expected post-2012 tax regime. Graph 8.12 sets out the responses to this question. Notably, only three respondents consider that their models are consistent.

Anticipating selected post 2012 changes in the design of actuarial models being built for Solvency II may have a significant impact. Under the post-2012 regime, there will be only two categories of business for tax purposes. Also, for gross roll up business and new protection business, which together account for a large proportion of many companies, there will no longer be a need to consider interactions between I-E and trade profits (previously called Notional Case I Profits). This is a significant simplification particularly when modelling tax losses and averse scenarios. Significantly for some companies, it will be possible under the post-2012 regime to recognise a deferred tax asset for gross roll-up business (GRB) losses.



Graph 8.12: Consistency with expected post-2012 tax regime

3

4

22

Yes

Partly

No / not yet considered

4.8.5 Research & development tax credit We asked if companies are claiming Research and Development tax credits on their Solvency II project spend. Only two respondents stated that they are doing so, with a further 13 respondents currently undecided. These findings are summarised in Graph 8.13.

Relief for qualifying revenue expenditure is available for large companies as an enhanced tax deduction of 130 percent of the expenditure. There is also a relief for capital expenditure which gives a 100 percent deduction in the year of the expenditure. Expenditure on developing or customising new systems used within insurance companies can qualify as R&D. Claims have to be made within two years of the end of the accounting period in which the expenditure arises or the opportunity will be lost.

Graph 8.13: Companies claiming R&d tax credits on Solvency II project spend

2

14

13

Yes

No

Undecided




4.8.6 GuidanceWe were interested in whether respondents thought that there has been sufficient guidance from the regulator regarding the treatment of tax under Solvency II. The response was unanimous, with all 28 respondents to this question stating that they consider the level of guidance to be insufficient. This was not surprising, as EIOPA has already noted in their QIS5 report of March 2011 that tax was dealt with inconsistently during QIS5.

Further guidance from regulators is not expected until late 2011 at the earliest.


partnership, is a subsidiary of KPMG

Europe LLP and a member firm of the

KPMG network of independent member

firms affiliated with KPMG International

Cooperative, a Swiss entity.



4.9 Own Funds

Solvency II refers to an insurers’ capital as ‘Own Funds’. We posed a variety of questions on Own Funds to assess how insurers were dealing with various aspects of the new regime. QIS 5 provided an insight into how Own Funds are ascertained and split.

A distinction is made between “basic own funds” and “ancillary own funds”. Basic own funds consist of (i) the excess of assets over liabilities and (ii) subordinated liabilities. This definition takes into account the mutual system, which does not know the concept of “own funds” (a corporate law concept). Ancillary own funds consist of various items, other than basic own funds, which can be called upon to absorb losses, e.g. the unpaid share capital or, in the case of a mutual system, calls for supplementary contributions.

4.9.1 Split of Own Funds The own funds of insurance companies are categorised into three tiers, according to their capacity to absorb losses. We asked how companies had split their Own Funds under QIS 5. Of the total Own Funds in the responding companies 98 percent is classified as Tier 1.

We also asked the same question but in relation to post Solvency II implementation. Again, of the total Own Funds in the responding companies 98 percent is classified as Tier 1.

Graph 9.1: Split of Own Funds under QIS 5

100%

80%

60%

40%

20%

0% Tier 3 Basic Tier 3 Ancillary Tier 1 Tier 2 Basic Tier 2

Ancillary

97.6% 97.9%

1.6% 1.3% 0% 0% 0.8% 0.8% 0% 0%

Under QIS 5, how was your Own After Solvency II implementation, Funds split? how do you expect your Own Funds

to be split?



4.9.2 Allocation of Basic Tier 2 and Tier 3 Own Funds We asked how companies intend to allocate their Basic Tier 2 and Tier 3 Own Funds.

The vast majority (70 percent) are expecting to allocate these on a ‘top down’ approach where Tier 2 capital is utilised first. Thirty percent of insurers expected to allocate these funds on a ‘bottom up’ approach where Tier 3 capital is assigned first.

Graph 9.2:Allocation of Basic Tier 2 and Tier 3 Own funds

3

7

“Top down”, where Tier 2 capital is utilised first

“Bottom up”, where Tier 3 capital is assigned first

4.9.3 Solvency 1 Allocation of Own Funds We asked companies what percentage of their Basic Own Funds are either hybrid capital or subordinated liabilities. The result was just under two percent being allocated in this manner.

4.9.4 Grandfathering of Own Funds We were also interested in what percentage of Own Funds is expected to be grandfathered. Overall just under five percent of Own Funds were expected to be grandfathered.

4.9.5 Adjustments to ring-fenced funds We asked companies whether they intend to make any adjustments to their ring-fenced funds.

The vast majority (71 percent) are not expecting to make any such adjustments.

Of the minority of insurers who were expecting to make an adjustment, the key areas of adjustment were excess assets over the notional SCR of the RFF being deducted from the solo and group Own Funds calculation or an internal model aggregation approach, allowing for the hierarchy fund structure.



Graph 9.3: Adjustments to be made for ring-fenced funds

8

20

Yes

No

4.9.6 Calculation of Expected Profits within Future Premiums (EPIFP)We asked whether companies calculated EPIFP as part of QIS 5. The vast majority (66 percent) did calculate EPIFP under QIS 5.

Graph 9.4: Calculation of EPIFP

21

10

1 Yes

No

Did not complete under QIS 5



4.9.7 Quantum of EPIFP We asked companies how material they estimate expected profits in future premiums to be within various classes of business.

It can be seen that the EPIFP are expected to be material or significant mainly for non-linked non profit business and also for unit linked business.

Graph 9.5: Significance of EPIFP by category of business

Significant impact

Material

Not material

Not applicable

Conventional with-profits business

Unitised with-profits business

Non-linked non-profit business

Unit-linked business

Annuities

Reinsurance accepted

Other

0% 20% 40% 60% 80% 100%

21% 36% 43%

10% 17% 34% 38%

38% 25% 28% 9%

21% 34% 28% 17%

7% 50% 43%

14% 7% 28% 52%

10% 29% 62%

4.9.8 Biggest challenge faced in calculating EPIFP We asked insurers what the biggest challenge was in the calculation of Expected Profits within Future Premiums (EPIFP).

It can be seen that the biggest challenge was viewed to be the complexity of the calculation (37 percent of respondents), followed by the contract boundaries (30 percent). Only 17 percent anticipated no major challenges.

Of the thirteen percent who suggested other challenges, the key challenges noted were: • Further guidance on calculation for protection products • The EPIFP definition not being prescriptive enough

Graph 9.6: Biggest challenge facing EPIFP calculation

9

11

5 4

1

12

10

8

6

4

2

0 Contract Complexity Assumption No problems Other

boundaries setting anticipated



4.10 Groups In this section we look at how key aspects of Solvency II will be treated within the Group as compared to subsidiary operations.

4.10.1 Leadership of SII Project We asked insurers how the overall solvency II project is being lead.

Just under half (48 percent) were leading the project centrally, with 17 percent employing a combination of a centralised and decentralised lead.

Graphs 10.1: Group Leadership of Solvency II

14

5

9

1

15

12

9

6

3

0 Centralised Decentralised Combination Not applicable

4.10.2 Model for Group vs Subsidiaries We asked insurers whether they would be using the same model for their Group as well as their subsidiaries.

Of the respondents to this question, ten are planning to use an Internal Model for all subsidiaries and, from these ten, seven are using the same model for all subsidiaries. Interestingly, there were also seven respondents who were planning to use both the Standard Formula and an Internal Model across different entities.

Graphs 10.2: Is the same model being used for both the Group and subsidiaries?

Yes, all use No, both All use Internal Yes, all use Not applicable Standard Formula Standard Model but varied same Internal

Formula and approach used Model Internal Model

used

8

7

6

5

4

3

2

1

0

3

7

3

7

5




4.10.3 Strategic valuation of Subsidiaries in SCR We asked insurers whether they have any subsidiaries valued as strategic for the equity risk module within their SCR.

The majority (55 percent) answered said no they did not.

Graphs 10.3: Strategic valuation of subsidiaries in SCR

9

11

Yes

No



of KPMG Europe LLP and a member firm of the KPMG network of

independent member firms affiliated with KPMG International Cooperative,



4.11 Profile of Respondents

4.11.1 Introduction In order to set the context for the findings of this survey, this section outlines the profile of survey participants including size of liabilities, composition of in-force business, and reporting basis.

4.11.2 Profile of respondents Graph 11.1 illustrates the size of our respondents’ Peak 1 liabilities plus WPICC. The companies responding represent a wide cross-section of the UK market ranging from very small to very large. Ten of the 32 respondents have Peak 1 liabilities plus WPICC of more than £10 billion, while nine have liabilities of less than £1 billion.

Graph 11.1: Respondents by size of Peak 1 insurance liabilities plus WPICC as at 31 december 2010

10

5

1

3

3

10

under £250m

£250m or more but less than £500m

£500m or more but less than £1bn

£1bn or more but less than £5bn

£5bn or more but less than £10bn

£10bn or more



Graph 11.2 shows the average composition of the respondents’ in-force business by Peak 1 insurance liabilities plus WPICC. Unit linked business remains the largest class of business, accounting for over a third of the total. The next largest class is annuities, which accounts for a fifth of the total.

Graph 11.2: Composition of in-force business in terms of Peak 1 insurance liabilities plus WPICC

20%

37%

14%

8%

14% 4%

4% Conventional with-profits

business

Unitised with-profits business

Non-linked non-profit business

Unit linked business

Annuities

Reinsurance accepted

Other

4.11.3 Size of actuarial function The relationship between the size of the respondents and the number of actuarial staff employed by them is shown in Graph 11.3.

As would be expected, the majority of respondents employing more than 100 actuarial staff have in-force liabilities of £10 billion or more (Peak 1 liabilities plus WPICC). While most respondents with less than £1 billion of in-force liabilities employ fewer than ten actuarial staff, there are a few smaller insurers with larger actuarial functions.

Graph 11.3: Number of actuarial staff employed split by size of Peak 1 liabilities plus WPICC

More than 100

Between 50 and 100

Between 10 and 50

Less than 10

under £250m £1bn or more but less than £5bn

£250m or more but less than £500m £5bn or more but less than £10bn

£500m or more but less than £1bn £10bn or more

0 3 6 9 12 15

1

1

1

5

2

326

3 3 3

2



4.11.4 Reporting basis Graph 11.4 splits participants by reporting basis and (for realistic reporters) shows which Peak bites. Of the 32 participants, 21 reported on a realistic basis and 11 on a regulatory only basis at year-end 2010. Of the respondents reporting on a realistic basis, Peak 2 was biting for 12 respondents.


Graph 11.4 Respondents by reporting basis and (for Realistic reporters) which Peak bites

11

9

12

Realistic reporter Peak 1 bites

Realistic reporter Peak 2 bites

Regulatory reporter

4.11.5 Pillar 1 or Pillar 2 biting? For 12 of the 30 respondents to this question (40 percent), the ICA capital requirement (i.e. Pillar 2) was more onerous than the Pillar 1 capital requirement as at year-end 2010. This is similar to the corresponding figure from last year, when 41 percent of respondents reported that Pillar 2 was biting.

66% of respondents reported on a realistic basis


5 ACKNOWLEDGEMENTS | 109

5 Acknowledgements

Many people dedicated their time to this survey and make it a success and we would like to take this opportunity to thank each of them. We had responses from 32 different companies and many more actuaries gave up their time for surveys to be completed. We appreciate the time and care that is put into your responses, the feedback you provided to us and your willingness to discuss your answers with us. A list of the companies participating in this year’s survey can be found in section 6.

The main authors of this report were:

david Alison Survey Manager

Saroop Rooprai Executive Advisor

James Latto Principle Advisor

Jaya Asthana Actuarial Advisor

Richard Li Executive Advisor

Michael Beck Actuarial Analyst

With additional input from Stephen Walker and Richard Dyble


6 LIST OF PARTICIPANTS | 111

6 List of participants

AEGON UK

Ageas Protect

Aviva UK Life and Pensions, Aviva Annuity UK

AXA Wealth

Bupa Health Assurance

Chesnara, Countrywide Assured, Save and Prosper

Children’s Mutual

Co-operative Insurance Society

Engage Mutual Assurance

Exeter Family Friendly

Hannover Life Reinsurance (UK)

Just Retirement

Legal and General

Liverpool Victoria Friendly Society

MetLife European Entities

New Ireland Assurance

NFU Mutual

Partnership Life Assurance Company

Pension Corporation

Police Mutual Assurance Society

Prudential UK Insurance Companies

Reliance Mutual

RGA UK Reinsurance

Royal London

Sanlam Life and Pensions

Skandia

St. James Place UK

Standard Life

Sun Life Financial of Canada UK

Unum

Wesleyan Assurance Society

Windsor Life


7 GLOSSARY | 113

7 Glossary

BLAGAB Basic Life Assurance and General Annuity Business

dTL Deferred Tax Liability

EIOPA European Insurance and Occupational Pensions Authority

EU European Union

FSA Financial Services Authority

FTEs Full - Time Equivalents

GRB Gross Roll Up Business

IAS 12 Accounting Standards for Income Taxes

ICA Individual Capital Assessment

IFRS International Financial Reporting Standards

IMAP Internal Model Application Process

MVAs Market Value Adjustments

ORSA Own Risk and Solvency Assessment

PAQC Pre-Application Qualifying Criteria

QIS 5 Quantitative Impact Survey

R&d Research & Development

SCR Solvency Capital Requirements

SLT Similar to Life Techniques

TPS Technical Practices Survey

WPICC With Profits Insurance Capital Requirement

XSI Excess Investment income


8 LIST OF GRAPHS AND TABLES | 115

8 List of graphs and tables Graph 1.1: Solvency II program – overall status

Graph 1.2: Current estimated budget split by size of Peak 1 liabilities plus WPICC

Graph 1.3: Changes to budget from the initial estimates approved by the Board

Graph 1.4: Number of Full Time Equivalents allocated to the Solvency II project split by size of Peak 1 liabilities plus WPICC

Graph 1.5: Proportion of Solvency II work carried out by internal staff, contractors and consultants, split by size of Peak I insurance liabilities plus WPICC

Graph 1.6: Areas in which the assistance of contractors and / or consultants are used

Graph 1.7: Areas in which actuaries were the main contributors

Graph 1.8: Rating of QIS 5 completion on a scale of 1 to 5

Graph 1.9: Main operational difficulties found in QIS 5 calculations

Graph 1.10: Impact of Solvency II on business areas

Graph 1.11: Communication to stakeholders

Graph 1.12: Challenges for Solvency II implementation

Graph 2.1: Progress on the development of the Best Estimate Liabilities for all companies

Graph 2.2: Progress on the development of the Best Estimate Liabilities for companies with less than £1bn Peak 1 liabilities plus WPICC

Graph 2.3: Progress of the development of the Best Estimate Liabilities for companies with more than £1bn Peak 1 insurance liabilities

Graph 2.4: Progress on the development of the Best Estimate Liabilities for companies allocating less than 20 FTE resources to their entire SII programme

Graph 2.5: Progress on the development of the Best Estimate Liabilities for companies allocating more than 20 FTE resources to their entire SII programme

Graph 2.6: Biggest challenge for modelling the Best Estimate Liabilities

Graph 2.7: Actions taken to improve data as a result of Solvency II requirements

Graph 2.8: Allowance for management actions in the calculations of the Best Estimate Liabilities

Graph 2.9: Management actions allowed in the calculations of the Best Estimate Liabilities – Realistic reporters

Graph 2.10: Management actions allowed in the calculations of the Best Estimate Liabilities – Regulatory reporters

Graph 2.11: Methods used to calculate reinsurance recoverable

Graph 2.12: Main challenges in the treatment of reinsurance



Graph 2.13: Progress on the development of the Risk Margin

Graph 2.14: Approach used in the calculation of the Risk Margin

Graph 2.15: Granularity of projections used in Risk Margin calculation

Graph 2.16: Are the methods used to calculate the Risk Margin the same across all risks?

Graph 2.17: Are the projection methods used to calculate the Risk Margin the same as the ORSA?

Graph 2.18: Tools used to calculate the Risk Margin

Graph 2.19: How would you best describe the impact of Solvency II on your with-profits business?

Graph 3.1: Method for the calculation of the SCR by size of companies

Graph 3.2: Risks for which Standard Formula approach is used in the Partial Internal Model

Graph 4.1: Most challenging risk to model – Market risks

Graph 4.2: Most challenging risk to model – Life risks

Table 4.1: Most challenging stresses to model in the Asset Liability Models

Graph 4.3: Main difficulties in the calculation of the SCR under the Standard Formula

Graph 4.4: Granularity level of the lapse stress

Graph 4.5: Management actions used in the calculation of the SCR under the Standard Formula - Realistic reporters

Graph 4.6: Management actions used in the calculation of the SCR under the Standard Formula - Regulatory reporters

Graph 5.1: Progress on the development of the Internal Model

Graph 5.2: Challenges on the use of an Internal Model

Graph 5.3: Submission of the PACQ

Graph 5.4: Submission of first self-assessment template

Graph 5.5: Tier 1 or Tier 2 category

Graph 5.6: Plan to have external validation of the Internal Model prior to submission to the FSA

Graph 5.7: SCR under IM compared to SCR under SF

Graph 5.8: Additional risks modelled in Internal Model, not covered under the Standard Formula

Graph 5.9: Development of Internal Model

Graph 5.10: Replicating portfolios and curve fitting

Graph 5.11: Approach to aggregation of risks under the Internal Model

Graph 5.12: Asset Liability Models in scope of Internal Model

Graph 5.13: Frequency of calibration of Internal Model

Graph 5.14: Granularity level of mortality and longevity stresses

Graph 5.15: Granularity of lapse stress

Graph 5.16: Plans to start dry runs on Internal Model

Graph 5.17: Management actions used in the calculation of the SCR under the Internal Model – Realistic Reporter


8 LIST OF GRAPHS AND TABLES | 117

Graph 5.18: Management actions used in the calculation of the SCR under the Internal Model – Regulatory Reporter

Graph 5.19: Management actions used in the calculation of the SCR under the Internal Model, Standard Formula and Best Estimate Liabilities

Graph 5.20: Readiness of Internal Model

Graph 5.21: Progress on the development of the documentation of the Internal Model

Graph 5.22: Frequency at which SCR numbers will be shared with senior management

Graph 5.23: Linking of remuneration to the Internal Model results

Graph 5.24: Development of an Economic Profitability measure

Graph 5.25: Profit and Loss Attribution and validation policy

Graph 5.26: Same risk categorisation used in the Internal Model and Profit and Loss Attribution

Graph 5.27: Items covered by Profit and Loss Attribution

Graph 5.28: Timing of Profit and Loss Attribution

Graph 5.29: Attribution of responsibility of the validation tasks

Graph 5.30: Timing of validation

Graph 5.31: Use of External models

Graph 5.32: Use of equity stress dampener in Internal Model

Graph 6.1: Level of actuarial function involvement in Pillars 2 and 3

Graph 6.2: Are there risks captured under ORSA but not SCR?

Graph 6.3: Frequency of assessment of solvency position under ORSA

Graph 6.4: Expected frequency of preparation of a formal ORSA report following ORSA vs Solvency position assessment

Graph 6.5: Are companies expected to set up a separate dedicated ORSA team?

Graph 6.6: Who is likely to be performing the ORSA?

Graph 6.7: Length of projection period for the ORSA

Graph 6.8: Expected date for carrying out first ORSA

Graph 6.9: Progress in key Pillar 2 and 3 aspects

Graph 6.10: Efficiency initiatives to speed up reporting

Graph 6.11: Are you increasing the frequency of hard closes?

Graph 6.12: Principal issues impacting reporting cycles

Graph 6.13: Different results in annual SFCR and Q4 QRT cycles

Graph 6.14 Commercial implications of SFCR public disclosure requirements

Graph 6.15: Is your existing financial reporting system suitable for SII reporting?

Graph 6.16: Have you started systems built on QRT?

Graph 6.17: Start date intended for commencement of QRT dry runs

Graph 6.18: Have you started preparation for IFRS Phase II?

Graph 6.19: Anticipated impact of IFRS Phase II on SII programme

Graph 6.20: Accounting for Insurance Business under IFRS post 2012



Graph 7.1: Considering the impact of SII on pricing

Graph 7.2: Impact to pricing in practice

Graph 7.3: Allowance for diversification in pricing between new and existing policies

Graph 7.4: Methods selected in allocating the diversification benefit

Graph 8.1: Extent to which loss absorbing capacity of deferred tax is recognised

Graph 8.2: Sources of future profits anticipated when valuing deferred tax assets

Graph 8.3: Discounting of deferred tax assets and liabilities

Graph 8.4: New business as source of future profits

Graph 8.5: Release of Risk Margin as source of future profits

Graph 8.6: Profit projections used for future income

Graph 8.7: Support for a simple flat rate approach to deferred tax recognition

Graph 8.8: Sophistication of tax

Graph 8.9: Consideration of policyholder tax under stress

Graph 8.10: Allowance for shareholder tax in the internal model SCR

Graph 8.11: Interaction between policyholder and shareholder tax

Graph 8.12: Consistency with expected post-2012 tax regime

Graph 8.13: Companies claiming R&D tax credits on Solvency II project spend

Graph 9.1: Split of Own Funds under QIS 5

Graph 9.2: Allocation of Basic Tier 2 and Tier 3 Own funds

Graph 9.3: Adjustments to be made for ring-fenced funds

Graph 9.4: Calculation of EPIFP

Graph 9.5: Significance of EPIFP by category of business

Graph 9.6: Biggest challenge facing EPIFP calculation

Graph 10.1: Group Leadership of Solvency II

Graph 10.2: Is the same model being used for both the Group and subsidiaries?

Graph 10.3: Strategic valuation of subsidiaries in SCR

Graph 11.1: Respondents by size of Peak 1 insurance liabilities plus WPICC as at 31 December 2010

Graph 11.2: Composition of in-force business in terms of Peak 1 liabilities plus WPICC

Graph 11.3: Number of actuarial staff employed split by size of Peak 1 liabilities plus WPICC

Graph 11.4: Respondents by reporting basis and (for realistic reporters) which Peak bites


Contact us: If you would like more information on any of the results set out in this report including electronic copies of the graphs and results set out within, or if you would like more information or assistance with regard to industry and technical actuarial practices, please contact:

David Alison Technical Practices Survey Manager Tel: 020 7694 8611 [email protected]

Listed below for your information are the Partners and Directors of the KPMG UK Life Actuarial practice:

Ferdia Byrne Partner Tel: 020 7694 2984 [email protected]

Paul Downes Associate Partner Tel: 013 1527 6902 [email protected]

Richard Care Partner Tel: 020 7694 2890 [email protected]

Claire Farrelly Associate Partner Tel: 012 9365 2623 [email protected]

Nick Dexter Partner Tel: 020 7311 5443 [email protected]

Gina Craske Director Tel: 020 7311 6015 [email protected]

John Jenkins Partner Tel: 020 7311 6199 [email protected]

James Cruttenden Director Tel: 020 7694 2763 [email protected]

Trevor Jones Partner Tel: 020 7311 5874 [email protected]

Gavin Coates Director Tel: 020 7311 1437 [email protected]

Gavin Palmer Partner Tel: 020 7694 5885 [email protected]

Michael Rallings Director Tel: 020 7311 6061 [email protected]

Tim Roff Partner Tel: 020 7311 5001 [email protected]

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. © 2011 KPMG LLP, a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative, a Swiss entity. All rights reserved. Printed in the United Kingdom. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. RR Donnelley | RRD 259150 | October 2011 | www.kpmg.co.uk

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technical practices survey 2011

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