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Solvency II News July 2011
Solvency II News July 2011
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PwC has recruited James Quin to lead PwC's insurance market reporting business in Europ and help insurers respond to the challenges posed by Solvency II and IFRS Phase II. The European Insurance and Occupational Pensions Authority (EIOPA) have announced the results of its second European insurance stress test. According to EIOPA, about 10% of European insurers would fail to meet future minimum capital requirements in an adverse macroeconomic scenario, but overall, the sector is well capitalized and well prepared for shocks, Europe's insurance regulator said Monday. Six groups, or 5% of the companies tested, would fail the sovereignstress segment of the adverse scenario. Interesting days... India is far from the Solvency II norms... and they do not care about it, do they? "We havent said we will accept it. Its a risk-based model, our country does not have that statistical database to go for that. I dont think we have taken a position on whether we will be using Solvency II. Solvency II is an European process. In India we have a factor-based process of solvency, which is formula centric. We are comfortable with that," said RK Nair, member (F&I), Insurance Regulatory and Development Authority. Interesting days... An interesting conference about the regulatory competition among countries Hedge Fund Re-domiciliation for Managers Conference 2011 (www.ibcevents.com/redomicile)
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Although the conference was about the regulatory benefits of key hedge fund jurisdictions, we have a very similar competition among key insurance and reinsurance jurisdictions, especially after the Solvency II Directive. According to Cheryl Packwood, CEO of Business Bermuda: The Hedge Fund Re-domiciliation conference is an important event and an excellent opportunity to discuss the benefits of Bermudas legal and regulatory framework as well as the cost advantages of basing in Bermuda for asset and fund managers such as lower costs, practical efficiencies associated with the use of private placement regimes and access to the many other benefits such as Bermudas tax neutrality or no remuneration caps, which can be attractive to investors. Could he speak about insurance and reinsurance? Absolutely. Which are the main factors currently driving the re-domiciliation of hedge funds and the relocation of hedge fund managers? 1. Increased taxes 2. New regulation 3. Investor flight to quality and transparency Interesting presentation at the conference: Comparing Key Jurisdictions & Their Attractiveness for Funds and Managers - Finding the best jurisdiction for your needs, assessing strengths and weaknesses - Local regulatory and fund structures available - Taxation of the fund and the manager - Internal and external factors to be assessed
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- Assessing whether to move Which were the conference sponsors? 1. Business Bermuda is the business organization of Bermuda resident service providers and international businesses which provide quality banking, insurance, reinsurance, legal, accounting, financial, trust, management and e-commerce services and products. Working alongside the Government and Bermudas international business industry to advance and promote Bermuda as one of the worlds foremost centres for international business. This collaborative effort aims to achieve real sustainable growth in foreign currency earnings, new business and employment opportunities while educating the local and international business community of the islands regulations and advantages. 2. Jersey Finance promotes and develops Jersey as an international finance centre. In addition to such marketing activity, it also co-ordinates the consultation process of proposed legislation and regulation affecting the Jersey finance industry, which results in a product offering that reinforces Jersey's position as an international finance centre of excellence. Jersey has been a world renowned centre for fund management, administration and establishment since the 1960s, although the emphasis today has shifted towards funds for institutional, specialist and expert investors. Its strong tradition of corporate governance and regulation has made Jersey a safe and secure environment in which to conduct business. 3. The Malta Financial services Authority (MFSA) is the single licensing and supervisory authority for all financial services activity. The Authority
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is an autonomous public institution set up by law. The sector overseen by MFSA includes banks, investment firms, insurance companies and financial intermediaries who provide a wide range of products and services on the domestic and internal markets. The regulation of the Malta Stock Exchange also falls under the responsibility of the MFSA. The MFSA is further responsible for the consumer education and consumer protection in the financial services sector. It also manages Maltas Registry of Companies. Who is missing? Ireland and definitely Luxembourg!
The European Insurance and Occupational Pensions Authority (EIOPA) have announced the results of its second European insurance stress test
It is important to start from the official definitions, to understand better the results of the stress test.
Stress Test
Under its regulation, EIOPA is required to initiate and coordinate Union-wide stress tests to assess the resilience of financial institutions. This stress test included three main scenarios: a baseline, an adverse and an inflation scenario. Risks relating to both the asset and liability sides of insurers balance sheets were included. These risks are: interest rate, equity market, real estate, spread, life and non-life.
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Publication of Results
EIOPA publishes aggregate results for the whole market since the exercise is based on the future regulatory system Solvency II. This provides comparable and market-oriented results, depicting the impact of stress scenarios more realistically than under the current Solvency I regime. However, Solvency II has not yet been finalised and may in the end differ from the specifications used for the purpose of this stress test exercise.
result produced by the MCR calculation is bounded between 25% and 45% of the SCR, subject to an absolute minimum. These principles for SCR and MCR are applied at solo and group level, with the exception of the MCR, which only applies at solo entity level. The Solvency Capital Requirement (SCR), which is the starting point for the adequacy of the quantitative requirements, is defined as the potential amount of own funds that would be consumed by unexpected large events whose probability of occurrence within a one year time frame is 0.5%. This definition based on a probability measure allows (and sometimes mandates) the replacement of all or part of the standard formula with an internal model, when this can be shown to be better able to fulfil the directive requirements in relation to an undertakings particular risk profile. EIOPA points out though that individual internal models have not been approved yet to calculate the capital requirements under Solvency II.
Sovereign Risk
Country-specific yield curve movements were defined on the basis of macroeconomic assumptions for EU-Member States, Norway, Iceland, Switzerland and Liechtenstein. The magnitude of the resulting adverse yield curve movements was calibrated to reflect the outlook per member state and would therefore affect the pricing of sovereign bond holdings in insurance undertakings assets. The European Insurance and Occupational Pensions Authority (EIOPA) was established as a result of the reforms to the structure of supervision of the financial sector in the European Union.
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The reform was initiated by the European Commission, following the recommendations of a Committee of Wise Men, chaired by Mr. de Larosire, and supported by the European Council and Parliament. EIOPA is part of the European System of Financial Supervision consisting of three European Supervisory Authorities, the National Supervisory Authorities and the European Systemic Risk Board. It is an independent advisory body to the European Parliament and the Council of the European Union. EIOPAs core responsibilities are to support the stability of the financial system, and transparency of markets and financial products, as well as the protection of insurance policyholders, pension scheme members and beneficiaries. This stress test has been conducted in corporation with Finma the Swiss Financial Market Supervisory Authority
EIOPA emphasises that the stress test is based on hypothetical and severe stress scenarios and is not a forecast of what is likely to happen. The results of this stress test indicate that overall the European insurance market is well prepared for potential future shocks as tested in this exercise. However, data showed that approximately 10% of the participating groups and companies do not meet the MCR under the adverse scenario. 8% fail to meet the MCR in the inflation scenario. Based on data as of 31 December 2010, the European insurers which participated in the stress test showed an aggregate solvency surplus of 425 billion before the stress test scenarios are applied. The aggregate surplus decreases to 275 billion (minus 150 billion) when the adverse scenario is applied and to 367 billion (minus 58 billion) in the inflation scenario. The insurance groups and companies who did not meet the MCR threshold show a solvency deficit of 4.4 billion if the adverse scenario were to occur and 2.5 billion if the inflation scenario were to materialise. At the aggregate level, EIOPA identifies the main drivers of the results as being adverse developments in equity prices, interest rates and sovereign debt markets. On the liability side, non-life risks are more critical, triggered by increased claims inflation and natural disasters. Sovereign bond exposure was covered separately in a supplementary test. The results of the shock on sovereign bond yields show that approximately 5% of the participating groups and companies would not meet the MCR.
The aggregate surplus of 425 billion decreases to 392 billion (minus 33 billion) in this particular scenario. While the exercise was completed by 221 insurance and reinsurance groups and companies, headquartered in the European Union, Iceland, Liechtenstein, Norway and Switzerland, the results reported are for 58 groups and 71 companies due to aggregation of the results of companies within groups. This represents approximately 60% of the overall European insurance market and is above EIOPAs aim to include at least 50% of the insurance market of each country as measured by gross premium income. EIOPA emphasises that it is important to consider that the stress test is based on a future regulatory system and is not necessarily indicative of any current solvency problems. It rather highlights an exposure to the hypothetical risks and must be understood in the light of the current status of Solvency II during the development of the fifth Quantitative Impact Study. Over the coming months, the National Supervisory Authorities will discuss the results of the stress test with individual insurers.
In this context, several proposals have been discussed under the Hungarian Presidency, in particular:
Discussions will resume under the Polish presidency, which will start in July 2011. Should Council reach an agreement on this issue, their proposal would need to be endorsed by Parliament to be formally adopted as part of the Omnibus II Directive. Consequently, we continue to work on the assumption that the implementation date is 1 January 2013. A number of specific transitionals have also been proposed and are subject to the same European policy adoption process. As such firms should continue their preparations, making clear assumptions and building flexibility into their plans so they can update them as more information becomes available. We appreciate that firms are progressing their implementation plans, including those going through the internal model approval process. We are currently assessing the impact of the draft proposals and will continue to provide further clarification when we have a greater degree of certainty.
Solvency II Conference, Q&A from the FSA Standard formula, reviews and approvals
1. When does the FSA expect to be able to receive applications for all other (i.e., non-internal model) approvals i.e. other than internal models, for day 1 that are required by firms under the Directive? The FSA will be open to receive internal model applications from firms from 30 March 2012.
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By this time the FSA expects there to be significantly more certainty about the shape of the final regime. Accordingly, we have decided to also accept, from March 2012, applications in respect of other aspects of the Solvency II regime. Our ambition is therefore to be open for all applications from 30 March 2012.
This is without prejudice to the firms legal right to submit a completed application when the Solvency II Directive comes into effect at implementation and we have a legislative obligation to review and give our decision within six months of receipt. If a firm is not in pre-application, this does not preclude it from applying ahead of day one, but the firm should assume that it will not get a decision for day one. 5. Whats the benefit of being in pre-application for the firm and for the FSA? The introduction of a pre-application phase into IMAP is based on lessons learned from the review of other internal model regimes, including the implementation of the Capital Requirements Directive for banks. The benefits for firms include: - An ongoing dialogue with us regarding Solvency II requirements and our expectations, allowing feedback on a firms Solvency II implementation; - An ongoing dialogue and engagement with other regulators involved in the internal model application process through colleges of supervisors; and - Early identification of any risks and issues arising from a firms Solvency II implementation project. Benefits for us include: - Developing a robust and consistent approach to assessing sufficiently internal model applications; - Effectively and efficiently using our resources;
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- Ensuring supervisors and specialists can familiarise themselves with firms models and their risk management frameworks in advance before decisions on internal model applications need to be made; and - Enabling issues to be identified early, so contingency plans can be implemented by firms in case they cannot meet Solvency II internal model standards in time. 6. Will the FSA focus on/prioritise particular areas of the model in preapplication and leave some for the application stage? The first iteration of the firms work plan will set out the work to be conducted during the review and assessment phase. 7. When is the FSA open for model applications for a decision in time for day 1? We will be open for applications 9 months before implementation (1 January 2013) on 30 March 2012. Please see Q4 and Q13 regarding assumptions that firms can make about the likelihood of getting a day 1 decision. 8. Can I submit my completed application before 30 March 2012? There is nothing to stop you from doing so. However, the FSA will not be considering any applications until the application window opens on 30 March 2012. 9. When is the deadline for model applications for a day 1 decision? We will be open for two months to receive applications, until 31 May 2012. Firms submitting applications after this date should assume that they will not get a decision in time for day one of the new regime.
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All firms should have contingency plans that they can put in place in the event that their model is not approved. We will aim to give decisions as early on in the process as possible if the firm is unlikely to meet the standards. 10. How many firms do you expect to approve by day one? Until work commences on this in March 2012 we cannot take a view on this. If a firm is accepted into pre-application, keeps on track, submits a complete application from 30 March 2012 to 31 May 2012, then we will endeavour to give it a decision to approve the internal model. However, the firm is not guaranteed a yes decision. All firms should have contingency plans that they can put in place in the event that their model is not approved. We will aim to give decisions as early on in the process as possible if the firm is unlikely to meet the standards. If a firm is in pre-application and falls behind in its work, and/or does not submit a complete application, it should assume that it will not get a decision for day 1. 11. When will the FSA be able to give a decision so that a firm can put in place contingency arrangements for day 1? We will aim to give decisions as early on in the process as possible if the firm is unlikely to meet the required standards. We will issue minded to letters to firms in Q4 2012. 12. What contingency arrangements should I make?
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There remains the possibility that a firms application to use an internal model will fail to satisfy the tests and standards set out in the Solvency II Directive and under European legislation (to be) made pursuant to the Directive. As such, we do encourage firms to think about their contingency arrangements should this situation occur. The precise extent to which a firm devotes resources to its contingency arrangements is a matter for the firm to consider, but we are encouraging firms to give sufficient attention to this issue now so that if an internal model is not approved, the firm may carry on with its business on the Solvency II commencement date in full compliance with the Directives requirements. We appreciate that there are costs involved in establishing contingency plans; however, we are obliged to follow the Directives requirements which entails the possibility of a firm failing to meet the Directives internal model criteria for approval. 13. What are the FSAs processes for application? We will agree a work plan with a firm that takes it from May 2011 to the application window of 30 March 2012 to 31 May 2012. The agreed work plan will be monitored and reviewed quarterly. 14. What is the rationale behind the two-tier approach to the internal model approval process? Were taking a risk-based approach which necessarily implies focusing resources on the firms that have the highest impact on our objectives. This is consistent with the FSAs overall approach to regulation and we will be taking a risk-based approach to implementation as a whole.
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15. What is the difference between a top tier firm and other firms in preapplication? Firms in the top tier should expect in-depth reviews conducted by the FSA. As far as possible, the FSA will endeavour to ensure that these in-depth reviews are dovetailed with business as usual activity in order to reduce any risk of duplication. All other firms will be allocated resources based on the nature, scale and complexity of the firm. In practice this will be achieved through existing supervisory knowledge of the firm and the quantitative techniques and tools. 16. Is there a disadvantage for firms who are not in the top tier? No. All firms will be subject to baseline monitoring against their self assessment. Resources will be allocated to them based on existing supervisory knowledge of the firm as well as through the use of quantitative techniques and tools. In addition, we will leverage work already being done by firms to evidence their compliance with the tests and standards, in a structured way that provides greater clarity for firms and improves consistency of our review. 17. What types of firms are in the top tier? The top 10 UK firms by size, the Society of Lloyds incl. sister firms, subsidiaries of major EU groups where we participate in a supervisory college. 18. Will firms know if they are in the top tier?
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Yes, top-tier firms have been contacted by their Supervisor and will start to have discussions about what this approach means for them. 19. My firm is not in the top-tier, will we see a reduction in our IMAP special project fee? No. Chapter 9 of our Fees CP11/2 sets out the rationale for our revised methodology for the recovery of the IMAP SPF for 2011/2012 in particular, that IMAP SPF costs will: - Be recovered from the individual firm or a group of firms that receive the benefit of the regulatory work and are confirmed as being in preapplication as at 31 March 2011 as compared with our previous methodology which recovered costs from our estimation of the number of firms likely to seek model approval; - Be recovered in proportion to their size (straight-line recovery) using the same measures of size we use to calculate their periodic fees (premium income and liabilities) (paragraph 9.13); and - As with periodic fees, not directly relate to the actual resources applied to individual firms. Our fees policy statement will be published at the end of May. 20. Could my firms application be delayed because other supervisors are not as advanced in their implementation? For firms with EEA connections, we will co-ordinate our activities, where appropriate, with other regulators through the supervisory college. However, where we are not the group supervisor we can only give our view on the UK element of the model.
Firms which are part of a group will therefore need to liaise with their other supervisors also. 21. What work is the FSA doing with the industry? The FSA is working with the ABI through its committee of members. We will also use the FSAs regular Insurance Standing Group and subgroup meetings, with an increasing focus on implementation issues.
For some techniques, we will wish to engage with industry during the design and test phases e.g. designing reference portfolios that can be run in practice. We will announce further details on techniques in July 2011.
External review
3. What is meant by external review? An external review is external to the FSA, performed by a suitably skilled individual which may be the firms internal auditor/function. There is no requirement from the FSA for firms to conduct external reviews on any part of their Solvency II implementation. [At our Conference we announced a pilot with some firms to identify how we could leverage work already being done by firms to evidence their compliance with the internal model tests and standards, in a structured way that provides greater clarity for firms and improves consistency of review. The pilot will look at the external review work being done by firms in the area of data management.]
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