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Solvency II

Alok TiwariCEOAptivaa Consulting22nd February 2008


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Contents

1. Overview of Solvency II

2. Comparsion of Solvency Regime

3. Solvency Regime in India

4. Pillar 1 - Solvency Capital

5. Pillar 2 - Overview

6. Impact of Solvency II

7. Q&A


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Solvency II Introduction

Solvency II is the proposed new EU legislation which will governThe capital requirements of insurance companies.

European Commission drafts the European legislation, with adviceprovided by CEIOPS who compile detailed analysis according to a

framework of calls for advice prepared by the EuropeanCommission.

European Commission will then publish a Solvency II FrameworkDirective to be approved by the European Parliament and

European Council. This will set out the broad principles andoutcomes to be achieved under Solvency II.

Solvency II is a radical move from the current Solvency Iregulatory approach, a simple factor-based insurance solvencyregime that has been in-force since the early 1970s.


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Solvency II Key Features

A principles-based approach

Creates harmonisation across the EU

Balance between protection of policyholders and encouraging

efficient operations of companies

Drives use of integrated internal models

Retains proportionality for small & medium sized companies

Treats groups as economic entities

An economic approach to determining solvency capital

for European Insurers


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Solvency II Some of the Key Stakeholders

European

Parliament

Council

of Ministers

EIOPC

CEIOPS

European Commission

(DG internal market)

CFO ForumCRO Forum

CEA

AISAM / ACME

ICISA

Other stakeholders

National

Insurance

Associations

Insurance

Companies

Groupe

Consultatif

Source: CEA

Government, regulation Insurance industry


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Solvency II The Three Pillars

Pillar 1

Quantitative requirements

Calculation of technical

provisions

"Prudent person"

approach to investments

Solvency capitalcalculation:

- SCR and MCR

- internal model vs.

standard approach

Pillar 2

Qualitative requirements

and supervision

Enhanced internal

governance, controls, risk

management and

solvency self-assessment

Strengthened externalsupervisory review,

harmonised supervisory

standards and practices

Pillar 3

Prudential reporting and

public disclosure

Disclosure to supervisors

Public disclosure of the

financial condition and

solvency report

Group Supervision

Groups are recognised as economic entities


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The Solvency II Timeline

10 July 2007

SII Directive

proposal ispublished

2007 2008 2009 2010 2011 2012

Directive development(Commission)

Directive adoption(Council, EU Parliament)

Implementation(member states)

Government, regulation

2H 2011

UK FSA

rulesfinal

1,2,3: Stages of the Lamfalussy processBased on CEIOPS guidelines, 27 Sept 2007

2009 / 2010

Adoption

expected1

31 Oct 2012

Solvency II

operational

QIS 1 QIS 2 QIS 3

Nov 2007Results

published

Implementation

Insurance Industry activity

QIS 4

March toNov 2008

2010

Implementing

Measures2, andNational

Supervisor

Standards3

finalised


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Comparison of Solvency Regimes


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Comparison of Solvency Regimes: Solvency II vs Basel II

Concentrates primarily on

assets

Applies economic principles

to both assets and liabilities

Scope

Standard or internal

approach (full / partial)

Standard formula or

internal model (full / partial)

Approach

Credit, market (as per BI),operational

Underwriting, counterpartydefault, market & ALM,

operational

Main riskscovered

Reduce systemic risk in the

banking system

Protect policyholders against

bankruptcy

Objective

Mainly included in generalcalibrationExplicitly allowedDiversification

Separate models for credit,

market and operational risks

Integrated approachRisk models

Mixture of principle-basedand rule-basedMostly principle-basedMethod

Basel IISolvency II


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Solvency Guidelines - India


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Solvency Guidelines - India

Simple Factor Based Approach

Life Insurance

Linked business 2% of Reserve + 0.2% of Sum at Risk

Non Linked business 4% of Reserve + 0.3% of Sum at Risk

Health Insurance 2% of Reserve

General Insurance

Max (% of Premiums , % of Claims) Limited benefits of Reinsurance

* Indian insurers have to maintain a Solvency Margin of 150%.


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Pillar 1 - Solvency Capital


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Framework for Pillar 1

MCR

Assets Liabilities & Capital

free assets

market

valuemargin

best

estimate

Technical provision

Solvency Capital Requirement

(SCR)

Non-

hedgeableHedgeable

market

consist-

ent

valuation

all assets at

market value

Assets covering

technical provision

Assets

available

for SCR

excess capital


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Calculating the SCR - The Standard Formula

SCDefault SCMarket SCHealth SCNon Life SCLife

BSCR SCROp risk

SCR

The SCR is composed of:

Basic SCR (Market, Default and Underwriting)

Solvency Capital charge for Operational Risk

Solvency capital is assessed separately for each risk

Explicit allowance is made for diversification benefits

To promotes better risk management

To facilitate the transition to Partial Internal Models

: adjustment for risk mitigating effects of future profit sharing


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Pillar 2 - Overview


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Pillar 2 Qualitative Requirements and Supervision

Objective Entrench good governance to ensure policyholder protection

Key components

System of internal governance

Establish a robust system to demonstrate:

Sound and prudent management

Risk and capital mgt is part of strategic decision-making

Complete an Own Risk and Solvency Assessment (ORSA)

Inform the regulators about the results

Supervisory review process

To ensure compliance with the Directive

Capital add-ons for material deficiencies


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Risk Management Process:

Identification, Measurement,

Monitoring and Control

Pillar 2 Development of Own Risk and Solvency Assessment

1

2

3

4

5

6

7

8

9

10

Senior management responsible to oversee implementation, setting

policies, procedures

Identify & assess risks in activities,

processes, systems, people

Develop policies and measure risk

Monitor exposure and loss events

Ensure companies have

effective systems in place

Public disclosure of risk

exposure & quality of risk

management

Role of Supervisors

Disclosure

Regular evaluation of

strategies, policies,

procedures & practices

Board sets strategy and framework plus oversight

Information flows provide effective monitoring

Implement cost effective

solutions to mitigate risks

Developing an Appropriate RiskManagement Environment


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Impact of Solvency II


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Impact of Solvency II Current Readiness

Current Approach to Risk Management

comments0% 20% 40% 60% 80% 100%

Rest

Eastern

Germany

Italy

France

UK

Do not manage / Solvency I Internally discussing improved approach

Implementing or improving framework Already implemented a risk based framework

Other

28

38

14

116

198

48

Responses

Source: CEA Impact Assessment survey, March 2007

the new framework will turn the spotlight on the accurate

identification, measurement and management of risk. The new

rules will spur insurers to raise their game in this area.C McCreevy, European Commissioner


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Impact of Solvency II Expected Approach

Expected Method for Calculating SCR

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

Small

Small - med

Medium

Med - large

Large

Standard approach Partial model Internal model

Source: CEA Impact Assessment survey, March 2007

15> 2,500 million (life)

> 1,500 million (non-life)

Large:

24< 50 millionSmall:

% of respondentsNet premium in force

Definition of company size


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Solvency II Expected Impact on Insurers (1)

Improvement in risk management practices Need to integrate these practices into the management process

Possible change in organisational structure

Greater volatility in balance sheet

Possible move to less volatile asset classes

Greater diversification of assets and use of risk mitigants

Increased capital requirements for higher risks

More innovative risk management

Industry consolidation

Changes to product design

Revision of product diversification


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Increased focus on internal governance including Identification, measurement ,

monitoring and control.

Introduction of Operational Risk in the framework for Solvency II

4. Risk MitigationProgrammes

Integrated Reporting ( SA, KRI & LDM),

New Product & Activity ( including Outsourcing)

BCP/DRP

Risk Causes Process People Systems External E

Fe

99.99%Confidence level

CATASTROPHICLOSSEffect Severity

EXPECTEDLOSS UNEXPECTEDLOSS

RISK

Risk Governance Operational Risk Definition/ Governance/ Policies1. Self Assessments(SA)

Strategic Diagnostic Study

Risk & Control Self Assessment (RCSA )

LossProvisioning

Gross Income Allocation to calculatecapital under SA

Loss Data Capture

Loss Data Analysis

3. Loss DataManagement (LDM)

RskMangmen 2. Key Risk Indicator Key Risk Indicator (KRI)

AMA Capital calculation using LDA,SBA & HMA

Internal Control Supervision

Risk Measurement


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Temporary resourcing and cost issues Shortage of resources and increased implementation costs

Should be mitigated by principle of proportionality

Alignment of supervisory requirements with market practice

Improved international competitiveness

Integration of the EU insurance market

Solvency II is not just about capital,

it is a change of behaviourThomas Steffen, Chairman of CEIOPS


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Questions

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