Notes on the latest

Standard Formula Calibration

September 2014

Disclaimer: This presentation is the author’s personal reference guide to the technical specifications for the preparatory phase as published by EIOPA on the 30/04/14 and other supplementary material. The presentation in no way represents

or purports to represent regulatory bodies such as EIOPA or any national regulator and readers should refer to the official regulatory publications for the specific detail of the regulations proposed under the Solvency II Directive.

The author accepts no responsibility for any errors or omissions herein.

Recommend printing in double sided booklet format.

Based on the EIOPA technical specifications

for the Preparatory Phase

Introduction - Where are we?

2

• Solvency II Processes

• Solvency II Timetable

• Reference Documents

Solvency II Processes

Different levels of rules

Level 1: Framework Directive – Solvency II & Omnibus II Directives

Level 2: Implementing Measures – Delegated Acts (European Commission)

Level 2.5: Implementing Technical Standards (EIOPA)

Level 3: Guidance by EIOPA to ensure consistent implementation

and cooperation between Member States

Level 4: Rigorous enforcement of Community legislation by the Commission

3

4

Timetable

April – June 2014

June – Sept 2014

End Oct

2014

Dec-14 Mar-15

Feb 2015

End June 2015

July 2015

January 2016

Solvency II

Set 1 of ITS Public

Consultation

Final Set 1 of ITS

submitted to EU

Set 2 of ITS Public

Consultation

Final Set 2 of ITS

submitted to EU

Set 1 of Guidelines

Public Consultation

Publish Set 1 of

Guidelines

Publish Set 2 of

Guidelines

Set 2 of Guidelines

Public Consultation

Reference Documents*

5

Date Issued Document Type Ref NameOctober 2013 Guidelines for Prepartory Phase CP-13/09 FLOAR (pre-ORSA)

CP-13/011 Pre-application of Internal Model

CP-13/010 Submission of Information

CP-13/010 System of Goverance (SOG)

April 2014 Set 1 of ITS for Consultation CP-14/004 Ancillary Own Funds

(Close date June 2014 - CP-14/005 Internal Model Approval

Final October 2014 ) CP-14/006 Joint College Decision on IM

CP-14/007 Matching Adjustment Approval

CP-14/009 USPs

April 2014 Technical Specifications EIOPA-14/209 Technical Specifications on SF (Preparatory Phase) Part 1

EIOPA-14/210 Technical Specifications on SF (Preparatory Phase) Part 2

July 2014 Assumptions behind Tech Specs EIOPA-14/322 Underlying Assumptions behind SF Calibration

June 2014 Set 1 of Guidelines for Consultation EIOPA-14/036 Pillar 1

(Close date October 2014) EIOPA-14/019 Use of Internal Models

EIOPA-14/017 SOG & ORSA

EIOPA-14/016 SRP

EIOPA-14/015 Equivalence Assessment

EIOPA-14/029 Impact Assessment of Guidelines

•Please note: This presentation is primarily based upon the technical specification documents published in April and July 2014 although other documents listed above have been assessed against some of the items in this presentation. This presentation is a

guide and in no way represents or purports to represent regulatory bodies such as EIOPA or any national regulator. Readers should refer to the official regulatory publications for the specific detail of the regulations proposed under the Solvency II Directive.

The author accepts no responsibility for any errors or omissions herein.

Contents • Section 1: Valuation Pages

– General - Assets & Liabilities .................................................................................................... 8 - 10

– Technical Provisions, including discounting ...................................................... ...................... 11 - 31

– Proportionality & Transitional Measures .......................................................... ...................... 32 – 35

• Section 2: SCR using the Standard Formula

– Standard Formula & BSCR Calculation ..................................................................................... 37 - 49

– Operational Risk Module .......................................................................................................... 50

– Intangible Asset Risk Module ................................................................................................... 51

– Market Risk Module ................................................................................................................. 52 - 83

– Counterparty Default Module .................................................................................................. 84 - 95

– Life Underwriting Module ........................................................................................................ 96 - 109

– Non-Life Underwriting Module ................................................................................................ 110 - 152

– Health Underwriting Module ................................................................................................... 153 - 170

• Section 3: MCR & Own Funds

– MCR ………………………………......................................................................................................... 172 - 173

– Own Funds & Tiers ……………………………….................................................................................. 174 - 176

• Section 4: Miscellaneous

– Ring Fenced Funds ……………...................................................................................................... 178 - 180

– Financial & Insurance Risk Mitigation ………………...................................................................... 181 - 185

– Other: Captives, Participations, Groups, System of Governance........………………………………….................................................................................... 186 - 190

• Appendices

– Appendix 1 to 7 ………..……......................................................................................................... 192 - 199

6

Section 1: ValuationSection 1: Valuation

Overview: SII Balance Sheet

8

Valuation: General • The primary objective for valuation as set out in Article 75 of Directive 2009/138/EC (hereinafter referred to as “Directive” in

this document) requires an economic, market-consistent approach to the valuation of assets and liabilities: – Assets should be valued at the amount for which they can be exchanged between knowledgeable willing parties in an

arm’s length transaction. – Liabilities should be valued at the amount for which they could be transferred, or settled, between knowledgeable

willing parties in an arm’s length transaction. • Valuation of all assets and liabilities, other than technical provisions, should be carried out, unless otherwise stated in

conformity with international accounting standards (IFRSs) as endorsed by the European Commission in accordance with Regulation (EC) No 1606/2002. If those standards allow for more than one valuation method, only valuation methods that are consistent with Article 75 of Directive can be used.

• IFRSs also refer to a few basic presumptions, which are also applicable: – The going concern assumption. – Individual assets and liabilities are valued separately. – The application of materiality, whereby the omissions or misstatements of items are material if they could, individually

or collectively, influence the economic decisions that users make on the basis of the SII balance sheet. Materiality depends on the size and nature of the omission or misstatement judged in the surrounding circumstances. The size or nature of the item, or a combination of both, could be the determining factor.

• The hierarchy of high level principles for valuation of assets and liabilities should be used: 1) Undertakings must use quoted market prices in active markets for the same assets or liabilities. 2) Where the use of quoted market prices for the same assets or liabilities is not possible, quoted market prices in active

markets for similar assets and liabilities with adjustments to reflect differences shall be used. 3) If there are no quoted market prices in active markets available, undertakings should use mark-to-model techniques,

which are alternative valuation techniques that have to be benchmarked, extrapolated or otherwise calculated as far as possible from a market input.

4) Undertakings have to make maximum use of relevant observable inputs and market inputs and rely as little as possible on undertaking-specific inputs, minimising the use of unobservable inputs.

5) When valuing liabilities using fair value, the adjustment to take account of the own credit standing as required by IFRS 13 Fair Value Measurement has to be eliminated. In addition, when valuing after initial recognition, the adjustment to take account of the own credit standing as required by IFRS 13 & IFRS 7 has to be eliminated. 9

Valuation: Specific Items Pages 10 to 45 of the Technical Specifications goes through each of the IAS 1-41 and IFRS 1-13 detailing their applicability and the adjustments needed. See Appendix 1 for full of those highlighted adjustments as applicable. Specific valuation requirements for selected SII balance sheet items : • Intangible assets: Goodwill valued at zero. Other intangible assets can only have a value > 0 if they can be sold separately

and there is a quoted market price in an active market for the same or similar intangible assets.

• Participations: Holdings in related insurance and reinsurance undertakings (See Appendix 2: Definitions) are to be valued at the quoted market price in an active market. – Where no such price exists, and the participation is in an (re)insurer:

• Subsidiary undertakings have to be valued with the equity method that is based on a SII consistent recognition and measurement for the subsidiary’s balance sheet.

• Related undertakings, other than subsidiaries, would also be valued with the equity method using a SII consistent recognition and measurement for the holding’s balance sheet. However, if this is not possible, an alternative valuation method in accordance with the high level principles can be used (not clear if this is subject to approval).

• Where no such price exists, and the participation is other than an (re)insurer then value with the equity method consistent with SII, otherwise an IFRS equity method endorsed by the EC (with intangibles deducted) for related undertaking. If not possible for related undertakings, other than subsidiaries, an alternative valuation method in accordance with the high level principles.

• Contingent Liabilities: For SII purposes, material contingent liabilities have to be recognised as liabilities. The valuation of the

liability follows the measurement as required in IAS 37 Provisions, contingent liabilities and contingent assets, with the use of the basic risk-free interest rate term structure.

• Deferred Tax: Follows the recognition principles in IFRSs and be valued, other than deferred tax assets arising from the carryforward of unused tax credits and the carryforward of unused tax losses, on the basis of the difference between the values ascribed to assets and liabilities recognised and valued in accordance with Articles 75 to 86 of the Directive 2009/138/EC and the values ascribed to assets and liabilities as recognised and valued for tax purposes. A positive value to deferred tax assets only where it is probable that future taxable profit will be available against which the deferred tax asset can be utilised, taking into account any legal or regulatory requirements on the time limits relating to the carryforward of unused tax losses or the carryforward of unused tax credits.

10

Valuation: Technical Provisions

• SII requires undertakings to set up technical provisions which correspond to the current amount undertakings would have to pay if they were to transfer their (re)insurance obligations immediately to another undertaking.

• (Re)insurance obligations must be segmented at a minimum by line of business (LoB) when calculating technical provisions. See Appendix 3 to 5 for minimum prescribed LoBs. The principle of substance over form applies in any segmentation whereby segmentation should reflect the nature of the risks underlying the contract rather than any legal form of the contract or product naming under the contract. This may require contracts to be unbundled if they contain material elements of, say, nonlife and life obligations.

11

Technical Provisions

Hedgeable Non Hedgeable

Market Value Best Estimate Risk Margin

Discount Rate

Valuation: Contract Boundaries

• Contract boundaries have proven to be a contentious issue. A contract boundary is defined as all of the obligations relating to the contract, including obligations relating to unilateral rights of the (re)insurer to renew or extend the scope of the contract and obligations that relate to paid premiums.

• The contract therefore ends on at a contractual expiry date or a future date where the (re)insurer has a unilateral right (a) to terminate the contract; (b) to reject premiums payable under the contract; or (c) to amend the premiums or the benefits payable under the contract in such a way that the premiums fully reflect the risks. • Unilateral rights means where nether a policyholder nor a 3rd party (excluding supervisors) can restrict the exercise of the

(re)insurer’s right. Reputation risk or competitive pressure should not be considered as a limitation on an unilateral right. Restrictions on this right that have no discernible effect on the economics of the contract should be disregarded (discernible effect = discernible financial advantage).

• An ‘individual risk assessment’ means any individual assessment of relevant features of the insured person that allow the undertaking to gather sufficient information in order to form an appropriate understanding of the risks associated with the insured person.

• Some premium or benefit changes agreed upon at inception of the contract may depend on factors beyond the control of the (re)insurer (e.g. inflation, increase of salary). Such a change should not be considered an amendment in terms of contract boundaries provided that the same premium structure as agreed at the inception of the policy is used.

• Where a contract can be unbundled into two parts and where one of these parts has a unilateral right to terminate or to reject premiums payable, any obligations that do not relate to the premiums of that part which have already been paid do not belong to the contract, unless the undertaking can compel the policy holder to pay future premium of that part. Each part of the contract must have obligations that are not dependent upon the other and which can be clearly communicated to the policy holder.

• A ‘portfolio of insurance or reinsurance obligations’ means a set of obligations for which the (re)insurer can amend premiums and benefits under similar circumstances and with similar consequences. In relation to such a portfolios, where extent of the obligations of the (re)insurer under the contract are not known (e.g. delegated authority), an estimate of the boundaries of the contracts using all the available information in a manner consistent with the principles of the technical specifications can be made

12

Start End

Earlier of date contract entered into or date that

coverage begins.

End date in contract if fixed or otherwise at future date where

unilateral right of (re)insurer to terminate and/or reject

premiums payable.

Unilateral right of (re)insurer to amend premiums or benefits payable in such a way that the premiums fully reflect the risks (e.g. individual risk assessment). For premium due over that already paid the (re)insurer must be able to compel the policy holder to pay such future premium, whereby such a compulsion is legally enforceable.

Amended

End

Valuation: Contract Boundaries (cont)

Valuation: Best Estimate

• Best estimate calculation should allow for the uncertainty in the future cash-flows and the calculation should consider the variability of the cash flows in order to ensure that the best estimate represents the mean of the distribution of cash flow values. Allowance for uncertainty does not suggest that additional margins should be included within the best estimate.

• The best estimate is the average of the outcomes of all possible scenarios, weighted according to their respective probabilities. Although, in principle, all possible scenarios should be considered, it may not be necessary, or even possible, to explicitly incorporate all possible scenarios in the valuation of the liability, nor to develop explicit probability distributions in all cases, depending on the type of risks involved and the materiality of the expected financial effect of the scenarios under consideration. Moreover, it is sometimes possible to implicitly allow for all possible scenarios, for example in closed form solutions in life insurance or the chain-ladder technique in non-life insurance.

• The level of uncertainty in the BE is an important area to consider. For example, the PRA, in CP7/14 from March 2014, stated that “many firms use reserving methods that project forwards from historical data. On its own, this is unlikely to satisfy the Directive requirement for a probability-weighted average of future cash-flows, since not all possible future cash-flows — or the events that cause them — may be represented in the data”. The PRA refers to these items as ‘events not in data’, or ENID, and states that “firms should take ENID into account when calculating technical provisions”.

• Cash-flow characteristics that should, in principle and where relevant, be taken into consideration in the application of the valuation technique include the following: – Uncertainty in the timing, frequency and severity of claim events. – Uncertainty in claims amounts, including uncertainty in claims inflation, and in the period to settle & pay claims. – Uncertainty in the amount of expenses. Uncertainty in the expected future developments that will have a material

impact on the cash in- and out-flows required to settle the insurance and reinsurance obligations thereof (e.g. the value of an index/market values used to determine claim amounts). For this purpose future developments shall include demographic, legal, medical, technological, social, environmental and economic developments including inflation.

– Uncertainty in policyholder behaviour. – Path dependency, where the cash-flows depend not only on circumstances such as economic conditions on the cash-

flow date, but also on those circumstances at previous dates. – Interdependency between two or more causes of uncertainty.

14

Best estimate = probability weighted average of future gross cash-flows taking account of the time value of money using the appropriate risk free term structure for the applicable currency.

Valuation: Best Estimate (cont) • Cash-flow projections should reflect expected realistic future demographic, legal, medical, technological, social or economic

developments over the lifetime of the insurance obligations. Appropriate assumptions for future inflation should be built into the cash-flow projection with care should be taken to identify the type of inflation to which particular cash-flows are exposed (i.e. consumer price index, salary inflation).

• The projection horizon used in the calculation of best estimate should cover the full lifetime of all the cash in- and out-flows required to settle the obligations related to existing contracts on the date of the valuation, unless an accurate valuation can be achieved otherwise, and should be based on up-to-date and credible information and realistic assumptions. – Inflows include items such as future premiums & subrogation payments within contract boundaries but not investment

returns. – Outflows could be divided between benefits to the policyholders or beneficiaries, expenses that will be incurred in

servicing insurance obligations and other cash-flow items as follows: • The benefit cash out-flows (non-exhaustive list) should include items such as claims payments, maturity benefits,

death benefits, disability benefits, surrender benefits, annuity payments, and profit sharing bonuses. • All cash-flows arising from expenses that will be incurred in servicing all recognised contractual obligations over

the lifetime thereof must be taken into account including (non-exhaustive list) administrative expenses, investment management expenses, claims management expenses / handling expenses, acquisition expenses, and overhead expenses.

• Other items include (but not limited to) payments between firms & intermediaries related to the insurance obligations, payments firms & investment firms in relation to contracts with index-linked and unit-linked benefits, payments for salvage and subrogation, taxation payments which are, or are expected to be, charged to policyholders or are required to settle the insurance obligations.

• Where expert judgement is used is must be based upon expertise of persons with relevant knowledge, experience and understanding of the risks inherent in the business. Circumstances where expert judgement may be necessary when calculating the best estimate include in selecting the data to use, correcting its errors and deciding the treatment of outliers or extreme events, in adjusting the data to reflect current or future conditions, and adjusting external data to reflect the undertaking’s features or the characteristics of the relevant portfolio, in selecting the time period of the data, in selecting realistic assumptions, in selecting the valuation technique or choosing the most appropriate alternatives existing in each methodology, in incorporating appropriately to the calculations the environment under which the undertakings have to run its business.

15

Valuation: Best Estimate (cont) • Principle of substance over form applies: When discussing valuation techniques for calculating technical provisions, it is

common to refer to a distinction between a valuation based on life techniques and a valuation based on non-life techniques. The distinctions between life and non-life techniques are aimed towards the nature of the liabilities (substance), which may not necessarily match the legal form (form) of the contract that originated the liability. The choice between life or non-life actuarial methodologies should be based on the nature of the liabilities being valued and from the identification of risks which materially affect the underlying cash-flows. This is the essence of the principle of substance over form.

• The choice between life or non-life actuarial methodologies should be based on the nature of the liabilities valued and on the identification of risks which materially affect the underlying cash-flows.

• Assumptions underlying the calculation of the best estimate should be consistent with information provided by financial markets. The asset model should comply with:

1) It generates asset prices that are consistent with deep, liquid and transparent financial markets. 2) It assumes no arbitrage opportunity. 3) The calibration of the parameters and scenarios is consistent with the relevant risk-free interest rate term structure used

to calculate the best estimate. The asset model should be calibrated to reflect the nature and term of the liabilities (in particular of those liabilities giving rise to significant guarantee and option costs), the current risk-free term structure used to discount the cash flows, and a properly calibrated volatility measure.

• All relevant available data, whether external or internal data, should be taken into account in order to arrive at the assumption which best reflects the characteristics of the underlying (re)insurance portfolio.

• External data must meet the following requirements: a) Insurers are able to demonstrate that the use of data from an external source is more suitable than the use of data which

are exclusively available from an internal source. b) Insurers must know the origin of the data and the assumptions or methodologies used to process that data. c) Insurers identify any trends in the data from an external source and the variation, over time or across data, of the

assumptions or methodologies in the use of the data. d) Insurers are able to demonstrate that the assumptions and methodologies referred to in point b) and c) appropriately

reflect the characteristics of their portfolio of insurance obligations.

16

Valuation: Best Estimate (cont) • For life insurance obligations:

• Group policies may be calculated at an aggregate level provided there are no significant differences in the nature and complexity of the risks underlying the policies, the grouping of policies does not misrepresent the risk underlying the policies and does not misstate their expenses, the grouping of policies is likely to give approximately the same results for the best estimate calculation as a calculation on a per policy basis, in particular in relation to financial guarantees and contractual options included in the policies.

• No implicit or explicit surrender value floor should be assumed for the amount of the market consistent value of liabilities for a contract which means that if the sum of best estimate & risk margin of a contract is lower than the its surrender value there is no need to increase the value of insurance liabilities to that of the surrender value.

• (Re)insurers shall identify and take into account all financial guarantees and contractual options included in their (re)insurance policies and all factors which may materially affect the likelihood that policy holders will exercise contractual options or the value of the option or guarantee.

• A contractual option is defined as a right to change the benefits, to be taken at the choice of its holder (generally the policyholder), on terms that are established in advance. Thus, in order to trigger an option, a deliberate decision of its holder is necessary.

• A financial guarantee is present when there is the possibility to pass losses to the undertaking or to receive additional benefits as a result of the evolution of financial variables (solely or in conjunction with non-financial variables) (e.g. investment return of the underlying asset portfolio, performance of indices, etc.). In the case of guarantees, the trigger is generally automatic (the mechanism would be set in the policy’s terms and conditions) and thus not dependent on a deliberate decision of the policyholder / beneficiary. In financial terms, a guarantee is linked to option valuation.

• Best estimate for contractual options and guarantees must capture the uncertainty of cash-flows, taking into account the likelihood and severity of outcomes from multiple scenarios combining the relevant risk drivers and should reflect both the intrinsic value and the time value. For each type of contractual option insurers are required to identify the risk drivers which have the potential to affect (directly or indirectly) the frequency of option take-up rates considering a sufficiently large range of scenarios, including adverse ones.

• Future policyholder/beneficiary behaviour should not be considered independent of financial markets and the assumptions on policyholder behaviour should be appropriately founded in statistical and empirical evidence, to the extent that it is deemed representative of the future expected behaviour.

17

Valuation: Best Estimate (cont)

• For life insurance obligations (cont): • Best estimate should take into account future discretionary benefits whether or not those payments are contractually

guaranteed. • Future discretionary benefits, the distribution of which is a management action, means benefits of insurance contracts

whereby: – the benefits are legally or contractually based on one or several of the following results:

– the performance of a specified pool of contracts or a specified type of contract or a single contract; – realised or unrealised investment return on a specified pool of assets held by the (re)insurer; – the profit or loss of the (re)insurer or fund that issues the contract that gives rise to the benefits;

– the benefits are based on a declaration of (re)insurer and timing or the amount of the benefits is at its discretion. (Index-linked and unit-linked benefits should not be considered as discretionary benefits.)

• Assumptions about management actions should:

– be determined in an objective manner. – be realistic and consistent with the (re)insurer’s current business practice and business strategy unless there is

sufficient current evidence that the undertaking will change its practices. – be consistent with each other. – not be contrary to their obligations towards policyholders and beneficiaries or to legal provisions applicable to

the (re)insurance undertakings. – take account of any public indications by the (re)insurance undertaking as to the actions that it would expect to

take, or not take in the circumstances being considered. – take account of the time needed to implement the management actions and any expenses caused by them. – be able to verify that assumptions about future management actions are realistic through a comparison of

assumed future management actions with management actions actually taken previously by the insurance or reinsurance undertaking.

18

Valuation: Reinsurance Recoverables

• Best estimate calculated gross, reinsurance recoverable calculated separately, follow same principles & methodology, with any time difference in recoverable taken into account consistent with contract boundaries and the terms and conditions of the reinsurance provided. See Insurance Risk Mitigation – Principles & Detail – in Section 4.

• Recoveries from SPV, finite reinsurance and other coverages to be calculated separately. Cash-flows should only include payments in relation to compensation of insurance events and unsettled insurance claims. Where there is a potential mismatch between claims incurred and amounts recoverable (so called basis risk) due to coverage triggers or exclusions, the amount assumed to be recoverable should only be so to the extent that the basis risk is not material and that they can be verified in a prudent, reliable and objective manner. Non-life insurance obligations should be calculated separately for premium provisions and provisions for claims outstanding.

• The calculation of the best estimate of reinsurance recoverable must be adjusted to take account of the expected loss due to the default of the reinsurer with the counter-party adjustment based on an assessment of the probability of default of the counterparty, whether this arises from insolvency, dispute or another reason, and the average loss resulting (loss-given-default). The adjustment should be calculated as the expected present value of the change in cashflows underlying the amount recoverable from a counterparty resulting from a default of the counterparty at a certain point in time. – The assessment of the probability of default and the loss given default of the counterparty should be based upon

current, reliable and credible information such as credit spreads, ratings, regulatory environment, and financial disclosures by the counterparty. Some criteria to assess information reliability is neutrality, prudency and completeness in all material aspects.

– The determination of the adjustment for counterparty default should take into account possible default events during the whole run-off period of the recoverables. Any assessment of the probability of default should take into account the fact that the cumulative probability increases with the time horizon of the assessment.

– Point-in-time estimates which try to determine the current default probability should be used where appropriate. Through-the-cycle estimates, which try to determine a long-time average of the default probability, might be used if point-in-time estimates cannot be derived in a reliable, objective and prudent manner or their application would not be in line with the proportionality principle. Many credit ratings are on the basis of ‘through the cycle’ estimates. Where the analysis of time dependent probability of defaults is not disproportionate, the following equation can be used:

19

PDt = PD · (1-PD)t+1

Valuation: Reinsurance Recoverables (cont)

• If no reliable estimate of the recovery rate of a counterparty is available, no rate higher than 50% should be used, the degree of judgement that can be used in the estimation of the recovery rate should be restricted, the average loss resulting from a default of a counterparty should include an estimation of the credit risk of any risk-mitigating instruments.

• Specific treatment of Special Purpose Vehicle (SPV) recoverables: – Probability of default should be calculated according to the average credit quality step of assets held as collateral for

the coverage provided unless there is a reliable basis for an alternative calculation. – Where there is no reliable source to estimate its probability of default (i.e. there is a lack of credit quality step), the

following rules should apply: • SPV authorised under EU regulations (or by an equivalent authority): the probability of default should be

calculated according to the average rating of assets and derivatives held by the SPV in guarantee of the recoverable.

• Other SPV: They should be considered as unrated.

• Simplification (where application small <5%) for a specific counterparty and homogeneous risk group: where AdjCD = Adjustment for counterparty default BERec = Best estimate of recoverables (excluding counterparty adjustment) from reinsurance contracts with

that counterparty in relation to that homogeneous risk group Durmod = Modified duration of the recoverables from reinsurance contracts with that counterparty in relation

to that homogeneous risk group PD = Probability of default of the counterparty over next 12 months

20

;0

PD1

PDDurBEmaxAdj modRecCD 5.0

Valuation: Risk Margin • Risk Margin is the amount over the best estimate that an independent third party (reference undertaking) would require to

take over the liabilities and is calculated by determining the cost of providing an amount of eligible own funds equal to the SCR required to support the liabilities over their lifetime. The rate used in determining the cost is the Cost of Capital rate (CoC), currently set at 6%. The calculation of the risk margin (CoCM) is calculated on a LOB basis as follows:

where CoCM = the risk margin, SCRRU(t) = the SCR for year t as calculated for the reference undertaking, rt = the basic risk-free rate for maturity t

• The risk margin should be calculated per LoB. This may be done by calculating the risk margin for the whole business allowing

for diversification and then allocated to the LoB (i.e allowance for diversification at LoB level is permitted). (re)insurers who calculate their SCR using an internal model are allowed to assume that the reference undertaking will also use the internal model.

21

CoCM = CoC · Σt≥0SCRRU(t)/(1+rt+1)t+1

Sum of discounted SCRs as per run-off of insurance liabilities

6% of

Valuation: Risk Margin (cont)

• Assumptions applicable to reference undertaking: – Transfer includes all inuring reinsurance, retrocession or SPV protections. – Reference undertaking has no other insurance liabilities or own funds prior to transfer. – Assets of reference undertaking selected such that market risk is minimised (unless assets associated with matching

adjustment assumed portfolio). – SCR of reference undertaking captures underwriting risk of the transferred business, residual market risk (if material)

other than interest rate risk, credit risk, operational risk. SCR can support reference undertaking over lifetime – Loss-absorbing capacity of TPs for the reference undertaking as per original undertaking (assume loss absorbing

capacity of deferred taxes of reference undertaking = 0). – Future management actions of reference undertaking are assumed to be those of original undertaking.

• Simplifications for the calculation of the risk margin are allowed based upon the nature, scale, and complexity of the risks in

the business. There are 5 hierarchies of simplifications that can be considered: – Full calculation without simplifications. – Approximate the individual risks or sub-risks within some or all of modules and sub modules. In practise, this means

simplifications for underwriting risk, counterparty default for reinsurance, and unavailable market risk. – Approximate the whole SCR for future years using proportionate measure. – Estimate all future SCRs ‘at once’. – Approximate risk margin as % of best estimate.

22

Valuation: Discounting Note: The assumptions set out in relation to discounting (e.g. Ultimate Forward Rate, Last Liquid Point, Credit Risk Adjustment) reflect the fact that the final methodologies are currently under development. Therefore none of those assumptions should be seen as indicating the final implementation, but rather as a pragmatic approach chosen for the preparatory phase only.

• Methodology for Basic Risk-free Interest Rate Term Structures

– For each currency and maturity, the basic risk-free interest rates will be derived on the basis of interest rate swap rates for interest rates of that currency adjusted for credit risk .

– The choice of reference instrument and last liquid points (LLP) by currency (for the purpose of the preparatory phase only) is provided by EIOPA (See Appendix 6).

– The adjustment has been determined on the basis of the difference between rates capturing the credit risk reflected in the floating rate of interest rate swaps and overnight indexed swap rates of the same maturity, where both rates are available from deep, liquid and transparent financial markets. The adjustment for credit risk will be determined as 50% of the average over one year of the difference between the interest rate swap rates and the overnight indexed swap rates of the same maturity. For the Euro this will be for the interbank offered rates for a three month tenor, other currencies are not specified. The adjustment cannot be lower than 10bps or higher than 35bps. The credit risk adjustment to be used in the preparatory phase will be provided by EIOPA.

– The interpolation between data points and extrapolation beyond the LLP has been done using the Smith-Wilson method.

23

Valuation: Discounting (cont) • Methodology for Basic Risk-free Interest Rate Term Structures (cont)

The ultimate forward rate (UFR)

– The ultimate forward rate (UFR) is the percentage rate that the forward curve converges to at the pre-specified maturity. The UFR is a function of long-term expectations of the inflation rate, and of the long-term average of the short-term real rate. As this value is assessed in line with long-term economic expectations it is expected to be stable over time and only change due to changes in long-term expectations.

– For the purpose of the preparatory phase it is assumed that the UFR for each currency is based only on the estimate of the expected inflation and the estimate of the long-term average of the short-term real rate.

– For pragmatic reasons, since it is very difficult to differentiate between long-term economic expectations of different currency areas in a globalized economy, for the purpose of the preparatory phase it is assumed that the UFR for each currency is equal to 4.2% (i.e. 2.2% long term growth rate and 2% inflation rate assumption). The exceptions are domestic currencies of Liechtenstein, Switzerland and Japan where the UFR is 3.2%.

The speed of convergence to the UFR

– The alpha parameter in the Smith-Wilson method determines both the speed of convergence to the UFR in the extrapolated part, and the smoothness of the curve in the interpolated part. Larger values of alpha give greater weight to the UFR, while smaller values of alpha give more weight to the liquid market data.

– For the purpose of the preparatory phase, the alpha parameter is calibrated so that the extrapolated part of the forward curve converges to within 1 bps from the UFR at a specified number of years from the LLP.

24

Valuation: Discounting (cont) • How does Solvency II deal with the illiquidity premium?......by a volatility adjustment or a matching adjustment.

25

Source: Quantifying Liquidity and Default Risks of Corporate Bonds over the Business Cycle

Valuation: Discounting - Volatility Adjustment

• Introduction: The objective of the volatility adjustment is to prevent pro-cyclical investment behaviour. The adjustment is applied before extrapolation , subject to supervisory approval, by adding to the zero coupon spot rates of the basic risk-free curve in the liquid part of the curve only (i.e. only until the LLP). For the preparatory phase, EIOPA has provided the relevant risk free curves including the VA for major currencies. The approach remains subject to further technical consideration & possible change.

• Volatility Adjustment (VA) – The Volatility Adjustment for each major currency (and country, where relevant) is based upon calculations of the spread

on government bonds and corporate bonds, securitisations and loans including mortgage loans in specified reference portfolios which is not attributable to any risk (i.e. the risk-corrected spread).

– The spread is defined as the spread between the interest rate that could be earned from assets included in the reference portfolio and the rates of the relevant basic risk-free interest rate term structure. This spread is calculated for each relevant currency and for each relevant country. For the purposes of the preparatory phase, the reference portfolios are unchanged from those used during the LTGA.

– Risk-corrected currency spread , denoted SRC-currency , is calculated separately for each currency as follows:

where: • wgov and wcorp denotes the ratio of government bonds and the ratio of all non-government bonds respectively

in the reference portfolio of assets for that currency. • Sgov and Scorp denotes the average currency spread on government bonds and the average currency spread of

all non-government bonds respectively included in the representative portfolio of assets of that currency. • RCgov and Rccorp denotes the portion of that spread that is attributable to a realistic assessment of expected

losses, unexpected credit risk or any other risks, of the government bonds and of all non-government bonds respectively included in the reference portfolio of assets for that currency (i.e. the risk correction, which is calculated in the same manner as the fundamental spread for the Matching Adjustment).

– The country risk-corrected spread, denoted SRC-country , should be calculated for each relevant national market as per the formula above using a reference portfolio based upon the actual assets held by the (re)insurer and denominated in the currency of that country. 26

Valuation: Discounting – Volatility Adjustment

• Volatility Adjustment (cont) – Where the SRC-country is less than 100 basis points, the volatility adjustment (VA) is as follows:

– Where the SRC-country is greater than 100 basis points and is higher than 2* SRC-currency , the volatility adjustment (VA) is as follows:

– In effect therefore, the volatility adjustment allows insurers to increase the relevant risk-free interest rate term structure for the calculation of the best estimate by 65% of the portion of the spread of a reference portfolio that is not attributed to “a realistic assessment of expected losses or unexpected credit or other risk of the assets”.

– The volatility adjustment applies only to the risk-free interest rates of the term structure that are not derived by means of extrapolation and the extrapolation of the term structure must be applied on those risk-free interest rates including the volatility adjustment.

– The volatility adjustment cannot be combined with the matching adjustment. – The specification confirms that the volatility adjustment should not change under SCR shocks. – The interplay between the volatility adjustment and the transitional measure with respect to the risk-free interest rate

structure is complicated, but effectively comes down to the transitional measure taking precedence, while the calculation is based on the volatility adjusted risk-free interest rate. The calculation under the transitional measure with respect to the technical provisions is based on the volatility adjusted risk-free interest rate, but it seems that the volatility adjustment can also be used in conjunction with the transitional measure as per the formulas for adjusting the discount rate during the transition period (for business sold before 1 January 2016 up to 16 years may be allowed):

27

VA = 0.65 ● SRC-currency

VA = 0.65 ● [SRC-currency +(SRC-country -2 ● SRC-currency )]

Valuation: Discounting - Matching Adjustment

• Introduction: The matching adjustment (MA), previously referred to as the (il)liquidity premium, allows (re)insurers to adjust the relevant risk-free interest rate term structure for the calculation of a best estimate of a portfolio of eligible insurance obligations such as annuities. Insurers using the MA will be subject to several risk management requirements, such as providing a liquidity plan, in addition to the usual risk management requirements. The adjustment is subject to prior supervisory approval and remains subject to further technical consideration and possible change.

• Matching Adjustment conditions:

a) (Re)insurer has assigned a portfolio of assets, consisting of bonds and other assets with similar cash-flow characteristics, to cover the best estimate of the portfolio of insurance obligations and maintains that assignment over the lifetime of the obligations, except for the purpose of maintaining the replication of expected cash-flows between assets and liabilities where the cash-flows have materially changed.

b) Portfolio of insurance obligations to which the matching adjustment is applied and the assigned portfolio of assets are identified, organised and managed separately from other activities of the undertakings, and the assigned portfolio of assets cannot be used to cover losses arising from other activities of the undertakings.

c) Expected cash-flows of the assigned portfolio of assets replicate each of the expected cash-flows of the portfolio of insurance obligations in the same currency and any mismatch does not give rise to risks which are material in relation to the risks inherent in the insurance business to which the matching adjustment is applied.

d) Contracts and/or policies underlying the portfolio of insurance obligations do not give rise to future premium payments. e) Only underwriting risks in the portfolio of insurance obligations are longevity, expense, revision & mortality risk. f) Where the underwriting risk includes mortality, the best estimate of the portfolio of insurance obligations does not

increase by more than 5% under a mortality risk shock applied to applicable mortality exposed policies (or group of homogeneous policies) greater in impact than a 15% increase in mortality rates.

g) Underlying policies include no options for the policy holder or only a surrender option where the surrender value does not exceed the value of the assets.

h) Cash-flows of the assigned portfolio of assets are fixed (except for inflation if such match the liabilities) and cannot be changed by the issuers of assets or any 3rd parties (unless any change results in sufficient compensation to allow it to obtain the same cash-flows by re-investing in assets of an equivalent or better credit quality).

i) Insurance obligations of an (re)insurance contract are not split into different parts when composing the portfolio.

28

Valuation: Discounting - Matching Adjustment

• Matching Adjustment (cont) – The matching adjustment is to be applied as a parallel shift to the entire basic risk-free term structure and shall be equal

to the difference of the annual effective rate, calculated as the implied single discount rate from reserves, of the portfolio of assigned assets and the annual effective rate calculated as the implied single discount rate from the reserves using the basic risk-free interest rate term structure.

– The matching adjustment shall not include the fundamental spread reflecting the risks retained by the (re)insurer and the fundamental spread shall be increased where necessary to ensure that the matching adjustment for assets with sub investment grade credit quality does not exceed the matching adjustments for assets of investment grade credit quality and the same duration and asset class.

– For the purpose of calculating the annual effective rate of the portfolio of assigned assets, expected cash-flows that are required to replicate the cash-flows of the portfolio of insurance obligations must include an adjustment to the cash-flow for the probability of default of the asset.

– In determining the fundamental spread relevant to each asset class, credit quality and duration, EIOPA assumed that the fundamental spread is: a) equal to the sum of the credit spread corresponding to the probability of default of the assets and the credit spread

corresponding to the expected loss resulting from downgrading of the assets. b) for exposures to Member States' central governments and central banks, no lower than 30% of the long term

average of the spread over the risk-free interest rate of assets of the same duration, credit quality and asset class, as observed in financial markets.

c) for assets other than exposures to Member States' central governments and central banks, no lower than 35% of the long term average of the spread over the risk-free interest rate of assets of the same duration, credit quality and asset class, as observed in financial markets.

– For the purposes of calculating the SCR, matching adjustment assets should be treated as if ring-fenced funds and excluded from the SCR interest rate shock and replaced by a scenario based calculation for spread risk whereby the fundamental spread shall increase by an amount equal to an equivalent increase in spread from the SCR shock multiplied by a reduction factor, as follows:

29

Rating AAA AA A BBB BB B CCC or lower

Reduction Factor 45% 50% 60% 75% 100% 100% 100%

Valuation: Discounting – VA versus MA

30

Matching

Adjustment

Volatility

Adjustment

Qualifying Liabilities

Portfolio of insurance

obligations confined to

underwriting risks from

longevity, expense, revision or

mortality risk. No future

premiums or options.

NA

Qualifying AssetsSegregated assets with fixed

cash-flows matching liabilities.NA

CalibrationSpread less expected cost of

defaults and downgrade on

assigned portfolio.

65% of spread less expected

cost of defaults and downgrade

on reference portfolio.

RequirementsSupervisory Approval &

Disclosure of Impact

Supervisory Approval &

Disclosure of Impact

Valuation: Transitional Discounting

• Transitional Measure for Technical Provisions – The transition from the Solvency I net technical provisions to the Solvency II net technical provisions can be applied

over 16 years on a linearly basis at the level of homogeneous risk groups subject to national supervisory approval. – The volatility adjustment can still be applied in the Solvency II calculation and the transitional deduction may be

limited by the national supervisor if its application could result in a reduction below the Solvency I net technical provisions (in essence, the transitional deduction may therefore only apply where the SII technical provisions is greater than the SI technical provision).

– The technical specifications only refer to technical provisions as at year end 2014.

31

Proportionality • Proportionality assessment:

– Step 1: Assess the nature, scale and complexity of underlying risks; – Step 2: Check whether valuation methodology is proportionate to risks as assessed in step 1, having regard to the

degree of model error resulting from its application; – Step 3: Back test and validate the assessments carried out in steps 1 and 2.

• Assessment should include all risks which materially affect (directly or indirectly) the amount or timing of cash flows required

to settle the (re)insurance obligations arising and should include all insured risks (e.g. inflation). • In mathematical terms, the nature of the risks underlying the insurance contracts could be described by the probability

distribution of the future cash flows arising from the contracts encompassing the degree of homogeneity of the risks, variety of different sub-risks or risk components of which the risk is comprised & their interrelation, the level of certainty, the nature of the occurrence or crystallisation of the risk in terms of frequency and severity, the type of the development of claims payments over time, the extent of potential policyholder loss (especially in the tail of the claims distribution) and the risk mitigation instruments applied, if any, and their impact on the underlying risk profile.

• Examples in life insurance include where the cash-flows are highly path dependent, or there are significant non-linear inter-dependencies between several drivers of uncertainty, or the cash-flows are materially affected by the potential future management actions, or risks have a significant asymmetric impact on the value of the cash-flows, in particular if contracts include material embedded options and guarantees, or the value of options and guarantees is affected by the policyholder behaviour assumed in the model, or undertakings use a complex risk mitigation instrument, for example a complex non-proportional reinsurance structure, or a variety of covers of different nature are bundled in the contracts, or the terms of the contracts are complex (e.g. in terms of franchises, participations, or the in- and exclusion criteria of cover).

• The degree of complexity and/or uncertainty of the risks are associated with the level of calculation sophistication and/or level of expertise needed to carry out the valuation. In general, the more complex the risk, the more difficult it will be to

model and predict the future cash flows required to settle the obligations arising from the insured portfolio. • A measurement of scale may also be used to introduce a distinction between material and non-material risks. Introducing

materiality in this context would provide some undertaking-specific threshold or cut-off point below which it would be regarded as justifiable to use simplifications for certain risks. Undertakings should use an interpretation of scale which is best suited to their specific circumstances and to the risk profile of its portfolio. Nevertheless the assessment of scale should lead to an objective and reliable assessment.

32

Proportionality (cont) • To measure the scale of risks, further than introducing an absolute quantification of the risks, undertakings will also need to

establish a benchmark or reference volume which leads to a relative rather than an absolute assessment. In this way, risks may be considered “small” or “large” relative to the established benchmark. Such a benchmark may be defined, for example, in terms of a volume measure such as premiums or technical provisions that serves as an approximation for the risk exposure.

• The three indicators - nature, scale and complexity - are strongly interrelated, and in assessing the risks the focus should be on the combination of all three factors. This overall assessment of proportionality would ideally be more qualitative than quantitative, and cannot be reduced to a simple formulaic aggregation

of isolated assessments of each of the indicators. • In terms of nature and complexity, the assessment should seek to identify the main qualities and characteristics of the risks, and should lead to an evaluation of the degree of their complexity and predictability. In combination with the “scale” criterion, undertakings may use such an assessment as a “filter” to decide whether the use of simplified methods would be likely to be appropriate. For this purpose, it may be helpful to broadly categorise the risks according to the two dimensions “scale” and “complexity/predictability”. • Model error - For the best estimate, this means that a given valuation technique should be seen as proportionate if the resulting estimate is not expected to diverge materially from the “true” best estimate which is given by the mean of the underlying risk distribution, i.e. if the model error implied by the measurement is immaterial. More generally, a given valuation technique for the technical provision should be regarded as proportionate if the resulting estimate is not expected to diverge materially from the current transfer value. • Materiality definition as per IAS - “Information is material if its omission or misstatement could influence the economic

decisions of users taken on the basis of the financial statements. Materiality depends on the size of the item or error judged in the particular circumstances of its omission or misstatement. Thus, materiality provides a threshold or cut-off point rather than being a primary qualitative characteristic which information must have if it is to be useful”

33

Proportionality (cont) • In ensuring the most appropriate level of granularity in the assessment of materiality, for the purposes of the calculation of

the technical provisions, the following should be taken into account: a) There are different levels at which the assessment could be carried out, namely the individual homogeneous risk

groups, the individual lines of business or the business of the insurer as a whole. b) A risk which could be immaterial with regard to the business of the insurer as a whole may still have a significant

impact within a smaller segment. c) Technical provisions should not be analysed in isolation but any effect on own funds and thus on the total balance

sheet as well as SCR should be taken into account in the assessment. • Assessment of the estimation uncertainty in the valuation - Due to the uncertainty of future events, any modelling of future

cash flows (implicitly or explicitly contained in the valuation methodology) will necessary be imperfect, leading to a certain degree of inaccuracy and imprecision in the measurement (or model error). Regardless of what methods should be applied for the valuation of technical provisions, it is important that an assessment of their appropriateness should in general include an assessment of the error implicit to the calculations. Undertakings are not required to specify the precise amount of the error, which in practice could be difficult. Instead, it is sufficient if there is reasonable assurance that the error implied by the application of the chosen method (and hence the difference between those two amounts) is immaterial.

• Where it is unavoidable for undertakings to use a valuation method which leads to a material error, the undertaking should document this and consider the implications with regard to the reliability of the valuation and their overall solvency position.

• Assessment of the error may be carried out by expert judgement or by more sophisticated approaches such as sensitivity analysis, comparison with other methods, scenario and back-testing.

• Where the use of a valuation technique results in a material increase in the level of uncertainty associated with the best estimate liability, undertakings should include a degree of caution in the judgements needed in setting the assumptions and parameters underlying the best estimate valuation. However, this exercise of caution should not lead to a deliberate overstatement of the best estimate provision. To avoid a double-counting of risks, the valuation of the best estimate should be free of bias and should not contain any additional margin of prudence.

34

Other Transitional Measures

• Additional transitional measures are also included in Omnibus II (O2) and these remain largely unchanged from those in the previous version. They include grandfathering provisions for basic own fund items that were issued prior to Solvency II coming into force and which are not classified as Tier 1 or 2 own funds. The following items can be used for up to 10 years from the introduction of Solvency II: – BOF that could have been used to meet up to 50% of the solvency margin can be treated as Tier 1 basic own funds. – BOF items that could have been used to meet up to 25% of the solvency margin can be treated as Tier 2 basic own

funds.

• There are two transitional measures relating to the Standard Formula SCR. These are: – The stress to equities can be phased in over seven years for equities purchased prior to Solvency II coming into force.

The stress will increase linearly from the level of the duration based equity risk sub-module, 22%, to the level of the full stress.

– The concentration and spread risk stresses applied to any debt issued by EU central governments or banks in the domestic currency of another EU country will effectively be zero until 2017 (i.e. the same level as if the debt had been issued in the domestic currency of that central government or bank). These will phase-in to the full specified stress by 2020.

• O2 contains a number of transitional measures. The transitional measures with respect to the risk-free interest rate structure

and the technical provisions. Other examples of transitional measures included in O2 are those relating to – own funds – non-compliance with the solvency capital requirement – supervisory reporting – disclosure requirements – the calculation of the SCR using the standard formula (regarding the parameters to be used when calculating the

concentration risk sub-module, the spread risk sub-module, or the equity risk sub-module) tradable securities or other financial instruments based on repackaged loans issued before 1 January 2011

35

Section 2: SCR & Standard FormulaSection 2: SCR & Standard Formula

Standard Formula SCR Overview • To avoid circularity, any reference to technical provisions in the individual standard formula modules should exclude the risk

margin. • A number of the standard formula modules are scenario based whereby the capital requirement is determined as the impact

of a specified scenario on the level of Basic Own Funds (BOF). The level of Basic Own Funds is defined as the difference between assets and liabilities (previously referred to as the net asset value or NAV by EIOPA) whereby the risk margin and subordinated liabilities are excluded from the calculation of liabilities.

• The change of BOF resulting from the scenario is referred to as BOF, defined to be positive where the scenario results in a loss of BOF.

• When calculating scenario: – The recalculation of TPs should allow for any relevant adverse changes in option take-up behaviour of policyholders. – Risk mitigation techniques (which meet the requirements) should be taken into account in the analysis of the scenario. – Scenario which result in an increase of BOF should not lead to a "negative capital requirement“ (i.e. BOF=0).

• Where the scenario stress is instantaneous, no management actions may be assumed. However, where it is necessary to reassess the value of technical provisions after a stress, future management action may be considered provided such action is objective, realistic, and verifiable (through a comparison of historical actions actually taken).

• SCR should correspond to the Value-at-Risk of the basic own funds subject to a confidence level of 99.5% over a one-year period. This calibration objective applies to each individual risk module.

• For the aggregation of the individual risk modules to an overall SCR, linear correlation techniques are applied in the standard formula.

• SCR should cover the risk of existing business as well as the new business expected to be written over the following 12 months.

• In the standard formula, for new non-life & Non-SLT health insurance business is taken into account in the premium & reserve risk, allowing for unexpected losses stemming from this business. However, the standard formula does not take into account the expected profit or loss of this business.

• For life insurance, SLT health insurance, Non-SLT Health lapse and Non-Life lapse the calculation of underwriting risk in the standard formula is based on scenarios of an instantaneous stress that occurs at the valuation date and therefore do not take into account the change in BOF over the 12 months following the scenario stresses nor the expected profit or loss of the business written during the following 12 months.

37

Standard Formula SCR Overview (cont)

38

Standard Formula SCR Overview (cont) • Method of calculation of SCR must be proportionate to the nature, scale and complexity of the risks being measured and

include: – Full internal model. – Standard formula. – Standard formula and partial internal model. – Standard formula with undertaking specific parameters (USP). – Simplifications.

• Two items need to be considered prior to the use of simplifications:

1) Assessment of nature, scale & complexity of the risks & appropriateness of simplification. 2) Assessment of model error results in a reasonable assurance that the model error is non-material. The (re)insurer should assess the model error that results from the use of a given simplification, having regard to the nature, scale and complexity of the underlying risks. The error should be identified by evaluating (in quantitative or qualitative terms) the deviation between

the nature, scale and complexity of the risk, and the assumptions underlying the simplified calculation A simplified calculation should not be considered to be proportionate if the error is material, unless the simplified calculation leads to a SCR which exceeds the SCR that results from the standard calculation. The error should be considered to be material if it leads to a misstatement of the SCR that could influence the decisions-making or the judgement of the user of the information relating to the SCR.

• Where inappropriate to calculate SCR using standard formula (SF) as firm’s risk profile deviates significantly (Article 119) from

assumptions underlying SF, supervisor may require the firm to use an internal model to calculate the SCR, or relevant risk modules.

39

Standard Formula SCR Assumptions • The standard formula for Solvency Capital Requirement (SCR) aims to capture the material quantifiable risks that most

(re)insurers are exposed to. It may however not cover all material risks a specific firm is exposed to as a standard formula is, by its very nature and design, a standardised calculation method, and is therefore not tailored to the individual risk profile of a specific undertaking. For this reason, in some cases, the standard formula might not reflect the risk profile of a specific firm and consequently the level of own funds it needs.

• The assessment of the significance with which the risk profile of an (re)insurer or group deviates from the assumptions underlying the SCR calculation, is an important process which (re)insurers and groups are required to perform prior to 2016. A firm must understand the assumptions underlying its SCR calculation and considers whether the relevant assumptions are appropriate by comparing those assumptions with its risk profile. The purpose of the assessment is not to review the appropriateness or calibration of the standard formula

• In accordance with Article 45(6) of Directive 2009/138/EC the undertaking will have to give information on the significance of the deviation of its risk profile from the assumptions underlying the SCR calculation to the supervisory authority in the FLAOR/ORSA supervisory report. This will require either an indication of why the deviation is significant or an explanation of and evidence why any deviations singly or taken together are not considered to be significant.

• The underlying assumptions for the overall structure of the standard formula can be summarised as follows: • Diversification effects are taken into account when capital requirements are aggregated by using correlation matrices.

For aggregating the individual risk sub-modules and modules to obtain the overall SCR, linear correlation techniques are applied. The setting of the correlation coefficients is intended to reflect potential dependencies in the tail of the distributions, as well as the stability of any correlation assumption under stress conditions.

• The SCR covers all quantifiable risk for existing business and also new business expected to be written in the following 12 months. However, in the scenario-based calculations, the changes in the value of assets and liabilities over the 12 months following the scenario stress are not taken into account, given the instantaneous nature of the stresses. Therefore, in such cases the capital requirements do not take into account the profit or loss of the business expected to be written during the following months. The formula-based calculations allow capturing risks associated with new business expected to be written in the following 12 months.

• The SCR is calibrated using the Value at Risk (VaR) of the basic own funds of a (re)insurer subject to a confidence level of 99.5 % over a one-year period. This calibration objective is applied to each individual risk module and sub-module.

40

Standard Formula SCR Assumptions (cont) • The underlying assumptions for risks not explicitly formulated in the standard formula calculation can be summarized as

follows: • Not all quantifiable risks have been explicitly formulated in the standard formula. As a consequence some risks which

are not explicitly included in the standard formula may be relevant for a particular firm. Some risks whose nature and calibration strongly depend on the single undertaking specificity may not be explicitly covered in the framework of the standard formula.

• The standard formula was designed from a solo perspective and applied mutatis mutandis for groups. Therefore, some risks which are relevant only for entities belonging to a group may not be covered by the standard formula.

• Certain risks are implicitly considered in other risk modules or sub-modules or in even multiple risk modules or sub-modules simultaneously. These risks are therefore considered to be implicitly formulated in the standard formula design and calibration.

• For illustration purposes, the following risks can be identified as being not explicitly formulated in the standard formula calculation (note that this is not intended to be an exhaustive list of excluded risks):

• Inflation risk: The sensitivity of the values of assets, liabilities and financial instruments to changes in the term structure of inflation rates, or in the volatility of inflation rates is not explicitly taken up as a separate risk sub-module in the standard formula. However, for the Life expense and SLT Health expense risk sub-modules as well as for the SLT Health disability-morbidity risk sub-module for medical expense (the capital requirement for the increase or decrease of medical expense payments), undertakings shall apply a 1 percentage point annual increase in expense inflation rates used for the calculation of technical provisions. For the health revision risk sub-modules the increase in annuity benefits is assumed to be related to changes in for example, inflation. Other sources of inflation risk are assumed implicitly in the calibration of the upward and downward interest rate shocks in the interest rate sub-module. However, the modelling of the Life and SLT Health underwriting risk modules should be based on the assumption that the risk relating to the dependence of insurance benefits on inflation is not material.

• Reputation risk: The risk related to the trustworthiness of an undertaking resulting in loss of revenues or destruction of shareholders value is not explicitly covered in the standard formula. The operational risk module explicitly excludes reputation risk and risks arising from strategic decisions. Given the limited amount of data or relevant information on past events of reputation risks, no reliable calibration of a capital requirement for reputation risk would be appropriate for the whole market. Therefore it is assumed inappropriate to cover reputation risk within the context of a standard formula approach.

41

Standard Formula Assumption (cont) • Liquidity risk: The risk that (re)insurers are unable to realize investments and other assets in order to settle their

financial obligations when they fall due is not explicitly covered in the standard formula SCR calculation. It is assumed that a capital requirement to cover liquidity risk would be ineffective and that it is appropriate to cover such risk by an explicit liquidity risk management policy within the overall risk management system. Undertakings are supposed to publicly disclose qualitative and quantitative information regarding their risk profile, including exposures to liquidity risk where these are material or in case of material changes in the liquidity risk profile.

• Contagion risk: (Re)insurers could be exposed to the risk that an adverse event or situation will spread from one undertaking to another. For example an insurer could be exposed to the financial weakness of other group entities affected by for instance market, reputation or operational risk. Conversely, some risks crystallizing at entity level can have knock-on or ripple effects on the wider group level. Such exposures to contagion risk are not explicitly covered in the standard formula, as the sources of contagion effects and the financial losses in case of contagion events are very specific to the business profile of individual undertakings and to the context of the group structure within which undertakings operate. Undertakings are to publicly disclose qualitative and quantitative information regarding their risk profile, including exposures to contagion risk and concentration risk where these are material or in case of material changes in the concentration risk profile.

• Legal environment risk: This is the risk that (re)insurers are unable to adapt their risk profile in response to sudden or unexpected legal environment, such as an unforeseen change in the legal retirement age. This is supposed to be understood as being different from legal risk directly affecting an undertaking, which is covered by a SCR for operational risk.

42

Undertaking Specific Parameters

• The issue of undertaking specific parameters (USP) has been a controversial one as they are not been considered for the preparatory phase and industry are pushing for a wider use of USPs.

• A consultation paper from EIOPA on the Implementing Technical Standards for USPs was issued in April 2014. The main points of this paper included:

• Only a subset of standard parameters within the underwriting risk modules can be potentially replaced by USPs. • Applications for use of USPs must be prepared on a prudent and realistic basis, and should include all relevant facts

necessary for assessment, including an assessment of how the criteria for completeness, accuracy and appropriateness of the data used will be fulfilled. The appropriateness of the standardised method for the undertaking’s data, whether their assumptions are fulfilled and whether data are relevant to the undertaking’s risk profile must also be addressed, including comparisons to the available methods could be reasonably and appropriately be applied.

• The use of USPs must be shown to better reflect the underwriting risk profile of the undertaking, for this purpose undertakings should consider the Own Risk and Solvency Assessment (ORSA) as an identification of where the SCR does not accurately reflect an undertaking’s risks is required within the ORSA

• Any application shall contain as a minimum the following: a) a specific start date from which the use of the USPs is requested; b) the subset of standard parameters which are requested to be replaced by USPs; c) the standardised methods used and the USP values obtained by using these methods; d) the calculation of the USP parameter the undertaking applies to use and information that the calculation is adequate; e) evidence that data used to calculate the USPs are complete, accurate and appropriate and they fulfil all of the Solvency II data quality requirements; f) a justification that each standardised method to calculate the USP for a single segment provides the most accurate result for the fulfilment of the requirements of the Solvency II Directive.

43

44

Use Use Test Test (Article 120)(Article 120) Demonstrate the internal model fits the business and is widely used in (no set pre-defined uses stipulated) and plays an important role in the System of Governance (and be subject to same), in particular, in: (a) Risk-management system & decision-making processes. (b) Economic and solvency capital assessment & allocation.

Statistical Quality Standards Statistical Quality Standards –– SQS (Article 121)SQS (Article 121) Methods used to calculate the probability distribution forecast shall be based on adequate, applicable and relevant actuarial and statistical techniques and be consistent with the methods used to calculate TPs & be based upon current and credible information and realistic assumptions. Must justify assumptions underlying model. Data used for the internal model shall be accurate, complete and appropriate. The internal model must rank risk sufficiently to ensure widely used & be a key part of System of Governance (SOG). Diversification is a core element of any insurance business model and must be quantified in any model, identifying key variables driving dependency, and justified by empirical evidence specifically taking into account any non-linear dependence & tail dependencies. Use of correlation or aggregation methods and assumptions a key area. May take account of future management actions that are reasonable, determined in objective manner, realistic and consistent, & allow time to implement such actions.

Calibration Standards (Article 122Calibration Standards (Article 122)) Time period or risk measure used must be such as to provide policyholders and beneficiaries a level of protection equivalent to 99.5% VAR over one year.

Profit & Loss Attribution (Article 123)Profit & Loss Attribution (Article 123) Internal model must be capable of showing causes and sources of P&L for each major business unit, and demonstrate how categorisation of risk and P&L attribution reflective of risk profile.

Validation Standards (Article 124)Validation Standards (Article 124) Regular cycle of independent model validation including performance monitoring, on-going appropriateness of its specification, and stress/sensitivity/scenario & back testing. Also analysis of consistency of assumptions & model output including model stability & model error. Validate (external & internal) data for accuracy, completeness and appropriateness & validate assumptions to ensure realistic & based upon credible & current information. “Richness of probability distribution forecast” assessed by: 1) Firm’s extent of knowledge about the risk profile as reflected in the set of events underlying the PDF (particularly in tail) and 2) Capability of the calculation method chosen to derive distribution of changes in basic own funds. Validation of correlation or aggregation methods and assumptions used. The use of expert judgement needs to be assessed for materiality and validated.

Documentation Standards (Article 125)Documentation Standards (Article 125) Document design and operational details of internal model including theory, assumptions, and mathematical/empirical bases underlying internal model so that a knowledgeable 3rd party could recreate results. Document weaknesses and uncertainties. Document model governance and model change policies.

Internal Model Requirements

SCR & Standard Formula

45

SCRSCR

BSCR

Mktinterest

Mktequity

Mktproperty

Mktspread

Mktcurrency

Mktconcentration

NLlapse

NLprem&res

LifeCat

Liferevision

Lifeexpense

Lifelapse

Lifedisability

Lifelongevity

Lifemortality

SCRoperational

HealthCat

NLCat

= included in the adjustment for the loss absorbing capacity of technical provisions under the modular approach.

SCRSCRnonnon--lifelife

SCRSCRhealthhealth

SCRSCRdefaultdefault

SCRSCRlifelife

SCRSCRintangibleintangible

Adjustment

SCRSCRmarketmarket

HealthNon SLT

HealthSLT

BSCR = Basic Solvency Capital Requirement. Adjustment = Adjustment for the risk absorbing effect of technical provisions and deferred taxes be made as follows:

• Where future discretionary bonuses (FDB) have a material impact upon the SCR, a gross and net SCR calculation may be applied (non-life and NSLT health insurance are excluded). The gross is without the benefit of changes to future bonus rates (i.e. BSCR) and where the interest rate shock is only applied to guaranteed benefits. The net is where future bonus rates have been changed in response to a shock on the basis of reasonable expectations and realistic management actions (i.e. nBSCR). The adjustment for technical provisions takes account of the risk mitigating effect provided by FDB to the extent undertakings can establish that a reduction in such benefits may be used to cover unexpected losses when they arrive.

• The adjustment for deferred taxes should be equal to the change in the value of deferred taxes of undertakings that would result from an instantaneous loss of an amount that is equal SCRshock as follows: For the purpose of calculating AdjDT, a decrease in deferred tax liabilities or an increase in deferred tax assets should result in a negative adjustment. For any positive change of deferred taxes the adjustment shall be nil. See Appendix 7 for more detail.

SCROp = Operational Risk charge.

46

SCR = BSCR + Adjustment + SCROp

AdjTP = max(min(BSCR nBSCR; FDB);0)

SCRshock = BSCR + AdjTP + SCROp

SCR & BSCR Adjustment

BSCR Calculation

Five modules for main BSCR calculation i & j plus intangible module, as follows:

1) SCRmkt = Capital charge for market risk.

2) SCRdef = Capital charge for counterparty default risk.

3) SCRlife = Capital charge for life underwriting risk.

4) SCRnl = Capital charge for non-life underwriting risk.

5) SCRhealth = Capital charge for health underwriting risk.

plus SCRintangible = Capital charge for intangible asset risk

Correlations:

47

Intangiblej SCRSCRSCRCorrSCRBSCRij iji,

i / j Market Default Life Health Non-Life

Market 1.00

Default 0.25 1.00

Life 0.25 0.25 1.00

Health 0.25 0.25 0.25 1.00

Non-Life 0.25 0.50 0.00 0.00 1.00

BSCR Diversification • The underlying assumptions for the correlations in the standard formula can be summarised as follows:

• The dependence between risks can be fully captured by using a linear correlation coefficient approach. • Due to imperfections that are identified with this aggregation formula (e.g. cases of tail dependencies and skewed

distributions) the correlation parameters are chosen in such a way as to achieve the best approximation of the 99.5 % VaR for the overall (aggregated) capital requirement.

• The graph below shows examples of the diversification from the BSCR formula showing benefits of between 20% and 40% depending upon quantum of the different sub-modules.

48

BSCR Diversification (cont) • The aggregation formula in the standard formula is based on the assumption that the dependence between the distributions

can be fully captured by linear correlations. In the mathematical literature a number of examples can be found where linear correlations are insufficient to fully reflect the dependence between distributions and where the use of linear correlations could lead to incorrect aggregated results, i.e. producing either an under-estimation or an over-estimation of the capital requirements at the aggregated level.

• Two main reasons can be identified for this aggregation issue: • The dependence between the distributions is not linear; for example there are tail dependencies. • The shape of the marginal distributions is significantly different from the normal distribution; for example cases where

marginal distributions are skewed. • Both characteristics appear in many risks which (re)insurers are exposed to. Tail dependence can exist in underwriting risks

(e.g. low-frequency and high-severity catastrophe events) market and credit risks. As to the second characteristic, it is generally known that the underlying distributions of the relevant risks of (re)insurers are not normal distributions. They are usually skewed and some of them are truncated by reinsurance or hedging effects.

• Because of these shortfalls of correlation technique and the relevance of such shortfalls for the risks covered in the standard formula, the choice of the correlation factors should avoid a mis-estimation of the aggregated risk. In particular, linear correlations are not an appropriate choice for the aggregation of risks in many circumstances.

• However, the choice of the correlation parameter for independent risks is not straightforward. If the underlying distributions are not normal, setting a correlation parameter of 0 can lead to an mis-estimation of the aggregated risk, hence to an mis-estimation of the required capital at the aggregated level. Where the shape or the type of the marginal distributions is known, sometimes it is possible to determine a correlation parameter which more closely reflects the aggregated risks. However, in practice, this often proves to be difficult. The shape of the underlying distributions is often not known or it differs across undertakings and over time. For example, even if the distribution of an underlying risk driver is known, hedging and reinsurance effects can modify the net risk in an undertaking-specific way. Hence where a standard formula correlation parameter between two risks assumed to be independent has to be specified, it appears to be acceptable to choose a low correlation parameter, reflecting that model risk might lead to an over- or under-estimation of the combined risk.

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SCROp= Operational Risk

• Operational risk is the risk of losses arising from inadequate or failed internal processes, or from personnel and systems, or

from external events. Operational risk increases together with the activity size as it stems from inadequate or failed internal

processes, personnel or systems, or from external events, unless the undertaking is well diversified and managed which

corresponds to a low value of the BSCR.

• The underlying assumptions for the operational risk module can be summarized as follows:

• The overall assumption in the operational risk module is that a standardized level of risk management is present.

• For unit-linked businesses the characteristics are similar to those of other life products. Therefore, the parameters will

evolve in line with the life parameter.

• In relation to the expense volume measure for unit-linked business, it is assumed that acquisition expenses are

exclusively relating to insurance intermediaries, which do not give rise to any operational risk.

• Operational risk should include legal risks, and exclude risks arising from strategic decisions, as well as reputation risks.

where

Op = Basic operational risk charge for all business (excl unit-linked business)

= Max (Oppremiums ; Opprovisions )

Oppremiums = 4% ● (GEP for life excl unit linked) + 3% ● (GEP for non-life) +

Max(0 ; 4% ● (change > 20% over year t-1 of GEP for life excl unit linked)) +

Max(0 ; 3% ● (change > 20% over year t-1 of GEP for non-life)).

Opprovisions = 0.45% ● (Gross TP for life excl unit linked) +

3% ● (Gross TP for non-life).

Expul = Annual expenses for unit linked business.

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SCROp = Min (0.3 ● BSCR, Op) + 0.25 ● Expul

SCRintangible= Intangible asset risk

• Intangible assets are exposed to two risks:

– Market risks, as for other balance sheet items, derived from the decrease of prices in the active market, and also from unexpected lack of liquidity of the relevant active market, that may result in an additional impact on prices, even impeding any transaction.

– Internal risks, inherent to the specific nature of these elements (e.g. linked to either failures or unfavourable deviations in the process of finalization of the intangible asset, or any other features in such a manner that future benefits are no longer expected from the intangible asset or its amount is reduced; risks linked to the commercialization of the intangible asset, triggered by a deterioration of the public image of the undertaking).

• Under IFRS, and IAS 38 in particular, an intangible asset needs to be identifiable and fulfil the criteria of control, as fol lows:

– An intangible asset is identifiable if it is separable or if it arises from contractual or other legal rights.

– The control criteria is fulfilled if an entity has the power to obtain the future economic benefits flowing from the underlying resource and to restrict the access of others to those benefits.

• Goodwill is not admissible as an asset under Solvency II.

• An intangible asset is only admissible if it meets the IFRS criteria above and there is evidence of exchange transactions for the same or similar assets, indicating it is saleable in the market place. If a fair value measurement of an intangible asset is not possible, or when its value is only observable on a business combination as per the applicable international standard, such assets should be valued at nil.

where IA = Fair value of intangible assets.

51

SCRintangible = 0.8 ● IA

SCRmkt = Market Risk Module

52

SCRSCRmarketmarket

Mktinterest

Mktequity

Mktproperty

Mktspread

Mktcurrency

Mktconcentration

Market risk arises from the level or volatility of market prices of financial instruments which have an impact upon the value of the assets and liabilities of the undertaking. In the market risk module, exposure to market risk is measured by the impact of movements in the level of financial variables, such as equity prices, interest rates, yield spreads, property prices, and exchange rates. It is assumed that the sensitivity of assets and liabilities to changes in the volatility of the market parameters is not material (if this is not the case, a (re)insurer will have to justify why using the standard formula is appropriate for them). It shall properly reflect the structural mismatch between assets and liabilities, in particular with respect to the duration thereof. It shall be calculated as a combination of the capital requirements for at least the following sub-modules: (a) the sensitivity of the values of assets, liabilities and financial instruments to changes

in the term structure of interest rates, or in the volatility of interest rates (interest rate risk).

(b) the sensitivity of the values of assets, liabilities and financial instruments to changes in the level or in the volatility of market prices of equities (equity risk).

(c) the sensitivity of the values of assets, liabilities and financial instruments to changes in the level or in the volatility of market prices of real estate (property risk).

(d) the sensitivity of the values of assets, liabilities and financial instruments to changes in the level or in the volatility of credit spreads over the risk-free interest rate term structure (spread risk).

(e) the sensitivity of the values of assets, liabilities and financial instruments to changes in the level or in the volatility of currency exchange rates (currency risk).

(f) additional risks to an insurance or reinsurance undertaking stemming either from lack of diversification in the asset portfolio or from large exposure to default risk by a single issuer of securities or a group of related issuers (market risk concentrations).

SCRmkt = Mkt Calculation

53

Six sub-modules for SCRMkt

1) Mktint = interest rate risk 2) Mkteq = equity risk 3) Mktprop = property risk 4) Mktsp = spread risk 5) Mktfx = currency risk 6) Mktconc = market concentration risk

A = 0 in interest rate up scenario, 0.5 in interest rate down scenario

rxc cr

rxcmkt MktMktCorrMktSCR

CorrMktUp Mktint Mkteq Mktprop Mktsp Mktfx Mktconc

Mktint 1

Mkteq A 1

Mktprop A 0.75 1

Mktsp A 0.75 0.5 1

Mktfx 0.25 0.25 0.25 0.25 1

Mktconc 0 0 0 0 0 1

SCRmkt = Mkt Calculation (cont)

54

Employee Benefits & Pensions • Where liabilities for employee benefits are recognised, these should be taken into account in the calculation for counterparty

default risk and for the sub-modules in the market risk module, irrespective of whether the management of such assets is outsourced or not. This could have a particular severe impact on (re)insurers that operate a defined benefits scheme, depending upon the current funding status and the underlying assets held..

Securities Lending Arrangements • The capital requirement for securities lending & repurchase arrangements should follow the recognition of items exchanged

in the Solvency II balance sheet, also taking into account contractual terms and risks stemming from the agreement. • If a lent asset remains in the balance sheet, and the asset received is not recognized, the relevant market risk charges

should be applied to the lent asset. In addition, a counterparty default risk charge (type 1 exposure) should apply to the lent asset, taking into account the risk-mitigation provided by the asset received if the latter is recognised as a collateral.

• If the lent asset does not remain on the balance sheet and the asset received is recognised, the relevant market risk charges should be applied to the asset received. In addition, if, following the contractual terms of the lending arrangement and the legal provisions applying in case of insolvency of the borrower, there is a risk that the lent asset is not given back to the lender at the end of the arrangement, although the received asset has been returned to the borrower, then a capital charge for counterparty default risk should be calculated, based on the initial value of the lent asset.

• In case where the lent asset and the asset received are both recognized on the balance sheet, the relevant market risk charges should be applied to both. In addition, a counterparty default risk charge should apply to the lent asset, taking into account the risk-mitigation provided by the asset received if the latter is recognized as a collateral.

• If the lending arrangement results in the creation of a liability on the balance sheet, the (re)insurer should consider this liability when calculating the interest rate risk capital charge.

• A repo-seller, having agreed to repurchase collateral at a future date, should take account of any risk associated with the collateral even though he isn’t presently holding it.

• A repo-lender should take account of any concentration, interest, spread or counterparty risk associated with the items exchanged for the collateral, taking into account the credit risk of the repo-seller.

SCRmkt = Mkt Calculation (cont)

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Look through Approach • To assess the market risk inherent in collective investment undertakings and other investments packaged as funds, it will be

necessary to examine their economic substance. 'Collective investment undertaking' means an undertaking for collective investment in transferable securities (UCITS) or an alternative investment fund (AIF). A look-through approach should be adopted in order to assess the risks applying to the assets underlying the investment vehicle. Each of the underlying assets would then be subjected to the relevant sub-modules.

• This look-through approach is applied for other indirect exposures to underwriting risk (such as in the case of investments in catastrophe bonds), indirect exposures to counterparty risk and indirect exposures to market risk.

• The exception is where liabilities for employee benefits are recognised, these should be taken into account in the calculation for counterparty default risk and for the sub-modules in the market risk module, irrespective of whether the management of such assets is outsourced or not. The capital charge is capped at the equity value of the investment in cases where the loss is legally limited.

• Where a number of iterations of the look-through approach is required (e.g. where an investment fund is invested in other investment funds), the iterations should be sufficient to ensure that all material market risk is captured.

• The above should be applied to both passively and actively managed funds, such as money market funds. • Where the look-through approach cannot be applied, the SCR may be calculated on the basis of the target underlying asset

allocation, provided such a target allocation is at the level of granularity necessary for calculating the SCR, and the underlying assets are managed strictly according to this target allocation. For the purpose of this calculation, data groupings may be used, provided they are applied in a prudent manner, and that they do not apply to no more than 20% of the total value of the assets of the (re)insurer.

• Where this approach is not possible and for all collective investments to which the look-through approach could not be applied, the equity type 2 charge shall be applied. In such cases, undertakings shall demonstrate to supervisors why it has not been possible.

• Where external asset management firms may delay publicising the fund composition, affected (re)insurers shall ensure that they are able to access the information required to identify the nature of all underlying assets in line with the requirements to monitor their solvency position.

SCRmkt = Mkt Calculation (cont)

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SPV notes should be treated as follows: 1) SPV notes having mostly the features of fixed-income bonds, authorized, where the SPV is defined as in point (26) of Article 13

of the Directive and meet the requirements set out in Article 211 of the Directive and has credit quality step 3 or better (i.e. investment grade): Their risks should be considered in the ‘spread risk’, ‘interest rate risk’ and concentration sub-modules according its credit quality step.

2) Others SPV notes, including those having significant features of equities (i.e. equity tranche notes): Their risks should be considered in the ‘equity risk’ sub-module. For this purpose the SPV notes should be considered as non-traded equities, unless they are traded actively in a financial market.

Mktint = interest rate risk

• Assumptions behind Interest Rate risk calibration

The interest rate risk sub-module should capture interest rate risk in relation to all interest rate sensitive assets and liabilities. The upward and downward shocked term structures are derived by multiplying the current interest rate curve by an upward and downward stress factor.

• It is important to note that the stress should only be applied to the basic risk free interest rates. The assumption underlying the design of the interest rate risk sub module is that in times of lower interest rates also the absolute shocks are lower, and vice versa.

• The interest risk sub module only captures interest rate risk that arises from changes in the level of the basic risk free interest rates.

• Volatility and changes in the shape of the yield curve are not covered in the standard formula. Shocks in the volatility of the term structure are usually only relevant where insurer's asset portfolio and/or their insurance obligations are sensitive to changes in interest rate volatility, for example where liabilities contain embedded options and guarantees. Insurers can also be exposed to volatility if they hold derivatives in their asset portfolios for interest rate hedging purposes.

• The interest risk module does not fully capture the risk of inflation or deflation. The undertaking should take into account any risk arising from inflation or deflation as part of their ORSA.

• The calibration of the interest rate shocks in the standard formula are based on the relative changes of the term structure of interest rates using the following 4 datasets: EUR government zero coupon term structures (1997 to 2009), GBP government zero coupon term structures (1979 to 2009), and both Euro and GBP LIBOR/swap rates (1997 to 2009). For each of the four individual datasets, stress factors were assessed through a Principal Component Analysis (PCA), according to their maturity. PCA is mathematically defined as an orthogonal linear transformation that transforms the data to a new coordinate system such that the greatest variance by any projection of the data comes to lie on the first coordinate (called the first principal component), the second greatest variance on the second coordinate, and so on. PCA is theoretically the optimum transform for given data in least square terms. PCA is a tractable and easy to implement method for extracting market risk factors. For each maturity, the mean of the results in the four datasets was taken as a single stress factor.

57

Mktint = interest rate risk (cont)

• Mktint

Up = ∆BOF|up and MktintDown = ∆BOF|down

where the change in net values of assets and liabilities due to revaluation of all interest rate sensitive assets and liabilities based on alterations to the interest rate term structures (as per the box to the right). The absolute increase of interest rates in the upward scenario at any maturity should at least 1%. When, for a given maturity, the initial value of the interest rate is negative, the undertaking should calculate the increase or decrease of the interest rate as the product between the sup or sdown shock and the absolute value of the initial interest rate

• Where exposed to interest rate movements in more than one currency, the capital requirement for interest rate risk should be calculated based on the larger of the two capital requirements after a downward and after an upward shock.

• For maturities not specified, the value of the shock shall be linearly interpolated. Note that for maturities greater than 90 years a stress of +20% / -20% should be maintained.

• For instruments which exhibit both fixed income and equity characteristics, both of these features should be stressed whereby the determination of which of the standard formula risk sub-modules apply should have regard to the economic form of the asset.

58

Mktint = Max(MktintUp , Mktint

Down)

Term Up Down

0.25 70% -75%

0.5 70% -75%

1 70% -75%

2 70% -65%

3 64% -56%

4 59% -50%

5 55% -46%

6 52% -42%

7 49% -39%

8 47% -36%

9 44% -33%

10 42% -31%

11 39% -30%

12 37% -29%

13 35% -28%

14 34% -28%

15 33% -27%

16 31% -28%

17 30% -28%

18 29% -28%

19 27% -29%

20 26% -29%

90 20% -20%

Mkteq = equity risk

• Assumptions behind Equity risk calibration Equity risk arises from the level or volatility of market prices for equities. Exposure to equity risk arises in respect of all assets and liabilities whose value is sensitive to changes in equity prices. In the standard formula, the equity risk sub-module only captures changes in the level of equity prices, and the module only covers a downward equity stress scenario.

• Many insurers are sensitive to changes in equity volatility either through the investments they hold (equities and equity derivatives) or through equity linked options and guarantees embedded in their liability portfolio. As a result, equity volatility has an impact particularly on insurers writing traditional participating business, investment linked business and other investment contracts. The Equity Risk module for these insurers may not be appropriate.

• The value of equity investments cannot fall below zero. • For the split between type 1 and type 2 equities it is assumed that type 2 equities consist of more risky equities than the

equities covered in the type 1 category. For this reason, the stress factor for type 2 equities is higher than for type 1 equities. • The undertaking holds a type 1 equity portfolio that is well diversified with respect to geography (developed market countries),

stock size (large, mid, small, micro cap), sectors and investment style (growth, value, income etc.). • The undertaking owns a private equity portfolio, as part of its type 2 equity portfolio, of mainly large private equity companies

which is well diversified with respect to geography, stock size, investment, financing style & vintage years. • The undertaking owns a commodity portfolio of liquid commodities as part of its type 2 equity portfolio which is assumed to

be well diversified with respect to the composition (proportion according to the worldwide production). • The undertaking owns a hedge funds portfolio of medium and large size hedge funds trading on a transparent basis which is

assumed that the portfolio is well diversified with respect to fund strategies and geographic location. • The undertaking owns a portfolio of equities in emerging markets that is well diversified with respect to geography, stock size

(large, mid, small, micro cap), sectors and investment style (growth, value, income etc.). • For the symmetric adjustment mechanism in the standard approach in the equity risk sub module it is assumed that equity

prices have a mean reverting behaviour. Therefore, when equity markets are rising the symmetric adjustment mechanism will increase the capital charge, and when falling will reduce the capital charge.

• For the duration based approach in the equity risk sub module it is assumed that a lower stress can be applied if the undertaking is exposed to a lower level of volatility of equities in the long term compared to the short term, consistent with the assumption of mean reverting behaviour of stock markets. It is assumed that for the business where the duration based approach is used, the typical holding period of equity investments is consistent with the average duration of such liabilities.

59

Mkteq = equity risk (cont)

• Type 1 equities are equities listed in regulated markets in the EEA or the OECD. Includes units or shares of alternative investment funds authorised as European Long-term Investment Fund, of collective investment undertakings which are qualifying social entrepreneurship funds or qualifying venture capital funds or shares of closed-ended and unleveraged alternative investment funds established or marketed in the Union.

• Type 2 equities are equities listed in stock exchanges which are not members of the EEA or OECD, equities which are not listed, hedge funds, commodities and other alternative investments. They shall also comprise all investments other than those covered in the interest rate risk sub-module, the property risk sub-module or the spread risk sub-module, including the assets and indirect exposures where a look-through approach was not possible.

• For equity shocks for Type 1 and Type 2 with correlation of 0.75 between Type 1 and Type 2:

• The justification of such an adjustment, in the context of a 99.5% percentile approach, is based on the underlying assumption that equity prices have a mean reverting behaviour. A systematic adjustment as per Article 106 will apply to allow for an adjustment based upon the current point in the cycle as follows:

where: CI = the current level of the equity index;

AI = the weighted average of the daily levels of the equity index over the last 36 months, using equal weights for all daily levels for the days in respect of which the equity index was determined.

• The symmetric adjustment has been calculated at a level of +7.5% on the basis of the current level of the equity index as of 31/12/2013 using an average of gross total return and non-total return measures for equity performance. Therefore the base levels of the two stresses are 39% for type 1 exposures and 49% for type 2 exposures. 60

rxc c r

rxc

eq Mkt Mkt CorrEq Mkt

Type 1 Type 2

Equity Shocki 46.5% 56.5%

The symmetric adjustment is included due to the following objectives: 1) To avoid (re)insurers being unduly forced to raise additional capital or sell their investments as a result of adverse movements in markets; 2) To discourage or avoid fire sales which would further negatively impact the equity prices – i.e. prevent a pro-cyclical effect of the capital requirements which could have a potential destabilizing effect on the economy.

Mkteq = equity risk (cont)

• A transitional measure for the standard equity risk for type 1 equities which are not subject to the duration-based approach can be assumed that undertakings are zero years into the transition, such that a 22% equity shock applies.

• As per the duration based equity approach for Article 304 for life insurers offering occupational-retirement-provision business, an equity risk charge of 22% should apply for holding periods > 12 years (subject to supervisory approval).

• For strategic participations, the equity shock is 22%, whether listed in regulated markets in the countries which are members of the EEA or the OECD (Type 1 equity) or not (Type 2 equity). The lower calibration of the equity risk stress on the investments in related undertakings which are of strategic nature should reflect the likely reduction in the volatility of their value arising from their strategic nature and the influence exercised by the participating undertaking on those related undertakings.

• The impact of the equity shock on the value of participations in financial and credit institutions shall be considered only on the value of participations that are not deducted from own funds.

• For the calculation of the risk capital requirement, hedging and risk transfer mechanisms should be taken into account according to the principles of financial risk mitigation. However, as a general rule, hedging instruments should only be allowed with the average protection level of six months unless part of a rolling hedging program.

– Where (re)insurers hold short positions in equity (including put options), these should only be netted off against long equity positions for the purposes of determining the equity risk charge only if the short position meets the requirements of an acceptable risk mitigation technique.

– Any other short equity exposure should be ignored when calculating the equity stress in the equity risk sub-module whereby the residual short equity exposure should not be considered to increase in value after application of the downward shock to equity values.

61

Mktprop = property risk

• Assumptions behind Property risk calibration The underlying assumptions for the property risk sub module can be summarized as follows: • The risk profile of any of the undertaking’s exposures to property located in third countries is not materially

different from the risk profile of European property markets. • The distributions of property returns are characterized by long left fat tails and excess kurtosis (signifying

disparity from normal distribution).

• It is assumed that the volatility of property prices is implicitly covered in the calibration of the property shock. • The property shock was calibrated using UK data extracted from the Investment Property Databank (IPD) indices. The IPD

indices are based on survey data collected from institutional investors, property companies and openended investment funds, and are the most widely used commercial property indices. Indices for most European markets and some countries outside Europe are produced, but for most European markets long time series are lacking. The indices consist of time series of income (rental yield) and capital growth for the main property market sectors – retail, office, industrial and residential.

• The calibration was based on monthly IPD total return indices for the UK market (1987 to 2008), because this dataset provides the greatest and most detailed pool of information. Total return indices are based on appraised market values rather than actual sales transactions, so by using them smoothed data were to some degree used (because appraisers tend to be “backward looking”, the current appraisal values mirror also previous valuation prices).

• Even though the calibration of the property shock is based on UK data, it is implicitly assumed that the UK property market can be used as a good proxy for the average European property market. Undertakings not exposed to the UK property market can rely on this assumption underlying the property risk module. It should also be assumed that the risk profile of any exposures to property located in third countries is not materially different from the risk profile of European property markets.

• The lower percentiles of the distribution of the “smoothed” property returns – i.e., the unadjusted index data –were derived by using nonparametric methods. The distributions of property returns are generally characterised by long left fat tails and excess kurtosis (signifying disparity from normal distribution). Different methods were applied to de-smooth the annual returns, but this resulted in even heavier left tails.

62

Mktprop = property risk (cont)

• Property risk arises as a result of sensitivity of assets, liabilities and financial investments to the level or volatility of market

prices of property.

• The property shock is 25% for all types of property. • The following investments should be treated as property and their risks considered accordingly in the property risk sub-

module: – Land, buildings and immovable-property rights. – Property investment for the own use of the insurance undertaking.

• Otherwise, the following investments should be treated as equity and their risks considered accordingly in the equity risk sub-module: – an investment in a company engaged in real estate management, – or an investment in a company engaged in real estate project development or similar activities, – or an investment in a company which took out loans from institutions outside the scope of the insurance group in

order to leverage its investments in properties. • Collective real estate investment vehicles should be treated like other collective investment vehicles with a look-through

approach. Also, for a company which serves as a holding structure for real estate assets and it is not considered a related undertaking.

63

Mkt prop = ∆BOF| property shock

Mktsp = spread risk

• Assumptions behind Spread risk calibration It is assumed that spreads will increase for all instruments in a 1 in 200 years event. It is therefore also assumed that there will be no diversification between the different sub-modules of the spread risk sub-module.

• Downgrades and default risk are not explicitly covered. Instead, both risks are addressed implicitly in the calibration of the factors of movements in credit spreads. The factors also implicitly address not only the change in the level of credit spreads, but also the shape of the term structure for the level of spreads.

• For bonds and loans other than residential mortgage loans, it is assumed that the spreads on all instruments increase, as undertakings are only exposed to the risk of a rise in credit spreads.

• An undertaking’s exposures in the form of covered bonds with a high credit quality step (0 or 1) and short or medium duration (less or exactly 10 years) are covered by the diversified pool of assets securing most of the bond’s value in case of a default of the issuer. The spread of the bond therefore also depends on this diversified pool of assets which is assumed to have a low volatility over the duration of the bond. Where covered bonds cannot be assigned to a high credit quality step (0 or 1) or they have a long duration a lower risk factor is assumed to be not appropriate.

• For securitisation positions it is assumed that the spread risk depends not only on the rating but also on the structure of the securitisation and the type and quality of the assets in the securitised pool. Therefore, the calibration of the spread shock factors has been differentiated between two types of securitisations and resecuritisation positions.

• A simplified calculation of the capital requirement for spread risk on bonds and loans is available if it is considered to be proportionate to the nature, scale and complexity of the risks an undertaking faces. The underlying assumption is that the asset portfolio is materially less diversified in terms of credit quality and duration compared to the portfolio used in the calibration of the standard formula. Therefore, the product of the duration and a risk factor dependent on the credit quality is assumed to be a prudent approximation for spread risk.

• The underlying assumption that all assets held by captives can be assigned to credit quality step 3 for the purpose of the simplified calculation for spread risk is that asset portfolios of captives are materially less diversified in terms of credit quality compared to the portfolio used in the calibration of the standard formula.

64

Mktsp = spread risk (cont)

where

• Mktspbonds = the capital requirement for spread risk of bonds and loans other than non-residential

mortgage loans.

• Mktspsecuritisation = the capital requirement for spread risk of tradable securities or other financial

instruments based on repackaged loans which are offered by way of securitisation within the meaning of point (61) of Article 4(1) of Regulation (EU) No 575/2013.

• Mktspcd = the capital requirement for spread risk on credit derivatives

• The determination of which of the standard formula risk sub-modules apply should have regard to the economic form of the asset. Where the asset can be considered as the composite of discrete components, it may be appropriate to apply the relevant stresses to each of these components separately. Otherwise, whichever of the fixed income or equity characteristics is predominant in an economic sense should be considered.

• The spread risk module is applicable to all types of ABS and tranches of structured credit products such CDOs, where:

– payments is dependent upon the performance of the exposure or pool of exposures; and

– the subordination of tranches determines the distribution of losses during the ongoing life of the transaction.

• Consideration should be given to the fact that callable bonds and other types of interest rate structures may not be called by the issuer in the event that spreads widen or interest rates increase. This may have an impact on the duration of the asset.

• A repo-seller, having agreed to repurchase collateral at a future date, should take account of any risk associated with the collateral even though not currently held. A repo-lender should take account of any concentration, interest, spread or counterparty risk associated with the items exchanged for the collateral, taking into account the credit risk of the repo-seller.

• Holdings in subordinated liabilities issued by the related undertaking are treated as financial instruments taking account of contractual terms and applying market stresses as appropriate (i.e. the interest rate, spread, currency, concentration and/or other risks).

• Where there are any assets which exhibit both fixed income and equity characteristics, both of these features should be taken into account when determining which of the standard formula’s risk sub-modules should apply.

65

Mktsp = Mktspbonds + Mktsp

securitisation + Mktspcd

Mktsp = spread risk - bonds

1 ) Bonds: The spread risk capital charge on bonds and loans other than residential mortgage loans is assessed through a factor

based calculation (starting from the market value of the instrument and taking into account its credit quality step and duration). The assumption is made that the spreads on all instruments increase, leading to an instantaneous reduction in the value of bonds. The undertaking should multiply the market value of the instrument with a risk factor stressi that depends on the credit quality step of the instrument, and the modified duration of the bond or loan denominated in years. For variable interest rate bonds or loans, the duration is equivalent to the modified duration of a fixed interest rate bond or loan of the same maturity and with coupon payments equal to the forward interest rate. The shock in spread risk for bonds and loans other than residential mortgage loans is designed as a concave function of duration ("kinking"). The reason for this is to ensure right incentives that long-term liabilities are backed by long term assets.

• The calibration of the risk factor stressi was based on the factors on Corporate Bond Indices from Merrill Lynch. Monthly

rebalanced sub-indices for EMU Corporates, for different maturity buckets and rating classes between 1999 and February 2010 were used. Each maturity bucket and rating class was split into new maturity buckets in order to be able to calibrate on more granular buckets.

• There are lower capital requirements for covered bonds. The underlying assumption is that a pool of assets of high credit quality covers the bond and therefore the shock factors for covered bonds should be somewhat aligned with the shocks for bond exposures of credit quality steps 0 or 1.

• A simplified calculation of the capital requirement for spread risk on bonds and loans is available if it is considered to be proportionate to the nature, scale and complexity of the risks an undertaking faces. The underlying assumption is that the asset portfolio is materially less diversified in terms of credit quality and duration compared to the portfolio used in the calibration of the standard formula. The simplified calculation of the capital requirement for spread risk on bonds and loans is assumed to apply to captives. The underlying assumption is that assets held by captives can be assigned to credit quality step 3 for the purpose of the simplified.

66

Mktsp = spread risk – bonds (cont)

1 ) Bonds (cont)

• To determine the spread risk capital requirement for bonds and loans other than residential mortgage loans (such as corporate bonds, subordinated debt and other investment instruments with equity and bond features) the following factors Fup should be used:

• Examples of the results of the spread risk capital requirement are as follows:

67

i ii

Upi

bonds

sp )duration ,(ratingFMVMkt

durationi (di ) Rating

years AAA AA A BBB BB B CCC or lower

Upto 5 0.9% * di 1.1% * di 1.4% * di 2.5% * di 4.5% * di 7.5% * di 7.5% * di

> 5 & =/< 10 4.5%+0.5%*(di-5) 5.5%+0.6%*(di-5) 7.0%+0.7%*(di-5) 12.5%+1.5%*(di-5) 22.5%+2.5%*(di-5) 37.5%+4.2%*(di-5) 37.5%+4.2%*(di-5)

> 10 & =/< 15 7.2%+0.5%*(di-10) 8.4%+0.5%*(di-10) 10.5%+0.5%*(di-10) 20%+1.0%*(di-10) 35%+1.8%*(di-10) 58.5%+0.5%*(di-10) 58.5%+0.5%*(di-10)

> 15 & =/< 20 9.7%+0.5%*(di-15) 10.9%+0.5%*(di-15) 13%+0.5%*(di-15) 25%+1.0%*(di-15) 44%+0.5%*(di-15) 61%+0.5%*(di-15) 61%+0.5%*(di-15)

Over 20 12.2%+0.5%*(di-20) 13.4%+0.5%*(di-20) 15.5%+0.5%*(di-20) 30%+0.5%*(di-20) 46.6%+0.5%*(di-20) 63.5%+0.5%*(di-20) 63.5%+0.5%*(di-20)

AAA AA A BBB BB B

1 year 0.9% 1.1% 1.4% 2.5% 4.5% 7.5%

3 year 2.7% 3.3% 4.2% 7.5% 13.5% 22.5%

5 year 4.5% 5.5% 7.0% 12.5% 22.5% 37.5%

7 year 5.5% 6.7% 8.4% 15.5% 27.5% 45.9%

10 year 7.0% 8.5% 10.5% 20.0% 35.0% 58.5%

15 year 9.7% 10.9% 13.0% 25.0% 44.0% 61.0%

Mktsp = spread risk – bonds (cont)

1 ) Bonds (cont)

• To determine the spread risk capital requirement for unrated bonds and loans other than residential mortgage loans, the following factors Fup should be used:

• Collateralised bonds and loans with no rating by a nominated ECAI and where the collaterals of those bonds and loans meet the criteria on risk mitigation techniques, shall be assigned a risk factor Fup as follows:

a) where the risk-adjusted value of the collateral > value of the bond or loan, Fup = 50% of risk factor above.

b) where the risk-adjusted value of the collateral < value of the bond or loan and where risk factor determined would result in a value of the bond or loan less than the risk adjusted value of the collateral, Fup = average of i) the risk factor above and ii) the difference between the bond value & the risk adjusted value of the collateral divided by the bond value.

c) where the risk-adjusted value of the collateral < value of the bond or loan and where risk factor determined would result in a value of the bond or loan greater than or equal to the risk adjusted value of the collateral, Fup = as per risk factor above.

• For variable interest rate bonds, the modified duration used in the calculation should be equivalent to a fixed income bond with coupon payments equal to the forward interest rate. If the modified duration is less than 1 year, it should be treated as 1 year.

68

durationi (di ) Fup

years

Upto 5 3.0% * di

> 5 & =/< 10 15%+1.7%*(di-5)

> 10 & =/< 20 23.5%+1.2%*(di-10)

Over 20 min(35.5%+0.5%*(di-20),1)

Mktsp = spread risk – bonds (cont)

1 ) Bonds (cont)

• For bonds from (re)insurers that do not meet their MCR the following Fup factors apply:

• For bonds from (re)insurers that do meet their MCR the following mapping between solvency ratios & credit quality applies

for determining Fup factors :

• For covered bonds, the risk factor Fup should be applied according to the table below, subject to the following: – the asset has a AAA or AA credit quality – the covered bond meets the requirements defined in Article 22(4) of the UCITS directive 85/611/EEC

69

durationi (di ) Fup

years

Upto 5 7.5% * di

> 5 & =/< 10 37.5%+4.2%*(di-5)

> 10 & =/< 15 58.5%+0.5%*(di-10)

> 15 & =/< 20 61%+0.5%*(di-15)

Over 20 min(63.5%+0.5%*(di-20),1)

durationi (di ) Rating

years AAA AA

Upto 5 0.7% * di 0.9% * di

> 5 min(3.5%+0.5%*(di-5);1) min(4.5%+0.5%*(di-5);1)

Solvency

AAA 196% AA 175% A 122% BBB 95% BB <75%

Mktsp = spread risk – bonds (cont)

1 ) Bonds (cont)

• EEA Sovereign - 0% capital requirement should apply for the purposes of this sub-module to all debt issued or guaranteed by EEA Governments in their underlying currencies, and ECB or institutions such as the European Investment Bank or the European Investment Fund or organisations detailed in CRD Directive Annex P, Part 1, No 4+5.

• Exposures to regional governments and local authorities established in the jurisdiction of a Member State shall be treated as

exposures to the central government for which a 0% capital requirement for spread risk applies, provided there is no difference in risk between such exposures because of the specific revenue-raising powers of the former, and specific institutional arrangements exist, the effect of which is to reduce the risk of default

• NonEEA Sovereign - For all other EEA debt, non-EEA government debt and non-EEA guaranteed debt, use Fup :

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durationi (di ) Rating

years AAA AA A BBB BB B CCC or lower

Upto 5 0% 0% 1.1% * di 1.4% * di 2.5% * di 4.5% * di 4.5% * di

> 5 to 10 0% 0% 5.5%+0.6%*(di-5) 7.0%+0.7%*(di-5) 12.5%+1.5%*(di-5) 22.5%+2.5%*(di-5) 22.5%+2.5%*(di-5)

> 10 to 15 0% 0% 8.4%+0.5%*(di-10) 10.5%+0.5%*(di-10) 20%+1.0%*(di-10) 35%+1.8%*(di-10) 35%+1.8%*(di-10)

> 15 to 20 0% 0% 10.9%+0.5%*(di-15) 13%+0.5%*(di-15) 25%+1.0%*(di-15) 44%+0.5%*(di-15) 44%+0.5%*(di-15)

> 20 0% 0% 13.4%+0.5%*(di-20) 15.5%+0.5%*(di-20) 30%+0.5%*(di-20) 46.5%+0.5%*(di-20) 46.5%+0.5%*(di-20)

Mktsp = spread risk – bonds (cont)

1 ) Bonds (cont)

Simplification for Mktsp bonds, may be used if:

1) Simplification proportionate to nature, scale & complexity of risks of (re)insurer.

2) Standard calculation is an undue burden on (re)insurer.

Simplification as follows:

where:

• MVbonds = Total market value of bond and loan portfolio.

• %MVibonds = Proportion of bond portfolio and loan portfolio held at rating i.

• %MVi noratingbonds = Proportion of bond and loans portfolio for which no credit quality step is available

• stressi = Defined as in the product of the average duration and the spread shock factors as below

• durno rating = Average duration of bond and loan portfolio with no rating weighted with the market value of the bonds

• ∆Liabul= the overall impact on the liability side for policies where the policyholders bear the investment risk with embedded options and guarantees of the stressed scenario, with a minimum value of 0 (sign convention: positive sign means losses).

The stressed scenario is defined as a drop in value on the assets by:

where spread shock factors are:

71

uli

rating nobonds

rating noibondsi

bondsbondssp ΔLiabmin(dur%MVstress%MVMVMkt )1;03.0

Rating AAA AA A BBB BB B CCC or lower

Capital Charge 0.9% 1.1% 1.4% 2.5% 4.5% 7.5% 7.5%

)1;03.0 i

rating nobonds

rating noibondsi

bonds min(dur%MVstress%MVMV

Mktsp = spread risk - secure 2) Securitisations (previously called Repackaged Loan Products and Structured Credit Products)

• Capital requirement on securitisation positions is the change in BOF from a spread shock calculated as:

• After 31/12/2014, a securitisation that does not comply with the 5% net retention rate foreseen in the CRD Directive will

receive a 100% capital requirement. • Type 1 securitisations:

– The exposure has been assigned a rating of BBB or better.* – Listed in a regulated market of an EEA or ECD country. – No subordination after delivery of enforcement/acceleration notice.* – SPV has legal ownership of underlying assets (i.e. true sale) with no claw-back provisions.* – Securitisation not exposed to a default of a service provider of SPV. – All assets underlying the securitisation belong are one of the following:*

• Residential mortgages or fully guaranteed residential loans. • Loans to small and medium-sized enterprises. • Auto loans and leases for motor vehicles, trailers, agricultural/forestry tractors, motorcycles or motor tricycles. • Leased property. • Consumer loans. • Credit card receivables.

– The pool of underlying assets may only include derivatives if used strictly for hedging currency & interest rate risk. – The pool of underlying assets do not include loans that were granted to credit-impaired obligors (e.g. bankrupt, poor

ECAI credit score, in default, self verified credit, etc.) and (except for credit card receivables) at least one payment has been made. For residential mortgages & consumer loans, a credit assessment according to the requirements of the Mortgage Credit Directive and the Consumer Credit Directive must have been performed.

• Risk factor for Type 1 securitisations:

72

i i

Upii )(ratingFdurationMV

Rating AAA AA A BBB

Fup2.1% * di 4.2% * di 7.4% * di 8.5% * di

Mktsp = spread risk - secure

2) Securitisations (cont)

• Type 2 securitisations shall include all securitisations that do not qualify as Type 1 securitisations and are not re- securitisation positions. Undertakings may use a transitional for securitisations issued before the entry into force of Solvency II, whereby the securitisation positions meet the criteria with a star * in the list above.

• Risk factor for Type 2 securitisations (modified duration not lower than 1 year):

• Risk factor for re-securitisations:

• Note: There has been much discussion about the EIOPA recommendations with respect to securitisation, particularly when the ECB and other European institutions are trying to encourage more credit in the economy by means of instruments such as securitisations. It has been reported that capital charges for high-level securitisations have been relaxed in the final draft of the delegated acts (beyond EIOPA’s most recent recommendations). Infrastructure investments, where insurers are also looking for changes, have remained unchanged.

73

Rating AAA AA A BBB BB B CCC or lower

Fup12.5% * di 13.4% * di 16.6% * di 19.7% * di 82% * di 100% * di 100% * di

Rating AAA AA A BBB BB B CCC or lower

Fup33% * di 40% * di 51% * di 91% * di 100% * di 100% * di 100% * di

Mktsp = spread risk examples

74

Mktsp = spread risk - CD

3) Credit Derivatives

• Applies a scenario-based approach to credit derivatives encompassing credit default swaps (CDS), total return swaps (TRS), and credit linked notes (CLN), where:

– the undertaking does not hold the underlying instrument or another exposure where the basis risk between that exposure and the underlying instrument is immaterial in all possible scenarios; or

– the credit derivative is not part of the undertaking’s risk mitigation policy.

• Credit derivatives which are part of the undertaking’s risk mitigation policy shall not be subject to a capital requirement for spread risk, as long as the undertaking holds either the instruments underlying the credit derivative or another exposure with respect to which the basis risk between that exposure and the instruments underlying the credit derivative is not material in any circumstances

where

75

Mkt spcd = Max (∆Derivative Value widening , ∆Derivative Value narrowing)

Widening of the

spreads (in absolute terms)

Decrease of the spreads (in relative

terms)

AAA +130 bp -75%

AA +150 bp -75%

A +260 bp -75%

BBB +450 bp -75%

BB +840 bp -75%

B or lower +1620 bp -75%

Unrated +500 bp -75%

Mktsp = spread risk - CD

Note on matching adjustment • For bonds such as corporate bonds, assets in the assigned portfolio shall be subject to an instantaneous

decrease in the value for spread risk according to the spread risk factors . • The technical provisions of the portfolio insurance or reinsurance obligations to which the matching adjustment

is applied shall be recalculated to take into account the impact on the amount of the matching adjustment of the instantaneous decrease in the value of the assigned portfolio of assets for spread risk with the following reduction factors:

• As the use of the matching adjustment is subject to prior supervisory approval once the Solvency II regime enters into force, the ability for undertakings to apply the matching adjustment for the purpose of the preparatory phase does not pre-empt any future decision by national supervisory authorities to approve or not to approve its application.

76

Rating AAA AA A BBB BB B CCC or lower

Reduction Factor 45% 50% 60% 75% 100% 100% 100%

Mktfx = currency risk

• The underlying assumptions for the currency risk sub-module can be summarised as follows: – •The sub-module takes into account currency risk arising from all possible sources, and the underlying

assumption of the market risk module design is that currency effects only appears in this sub-module, i.e. currency effects have been stripped out in the calibration of the other market risk sub- modules.

– For currencies pegged to the Euro, either by way of currencies participating in the European Exchange Rate Mechanism, or where a decision from the Council recognizes pegging arrangements to the Euro or where a pegging arrangement is established by law of the country establishing the country's currency, a reduced shock factor in the currency risk sub_ module is used. The underlying assumption is that for these currencies, the rate against the Euro will fluctuate within a limited band, and therefore the currency risk shocks against the Euro should be limited as well. The same reduced shock factors will apply between pairs of currencies pegged to the Euro, based on the same underlying assumption.

where • The local currency is the currency in which the undertaking prepares its financial statements. All other

currencies are referred to as foreign currencies.

• Mktfx C

up = max (0, ∆BOF| C upward shock ) and Mktfx C

down = max (0, ∆BOF| C downward shock )

• The calibration of the required currency stresses is set at ±25%.

• All of the participant's individual currency positions and its investment policy (e.g. hedging arrangements, gearing etc.) should be taken into account.c

77

Mktfx = Max (Mktfx CUp, Mktfx C

Down)

Mktfx = currency risk (cont)

The size of the shocks for certain non euro but pegged currencies takes into account a reduction factor as follows:

– Danish krone (DKK) against EUR = ±2.39%

– Bulgarian lev (BGN) against EUR = ±1.04%

– Lithuanian litas (LTL) against EUR = ±0.26%

– West African CFA Franc (XOF) against EUR = ±0.11%

– Central African CFA Franc (XAF) against EUR = ±0.11%

– Comorian franc (KMF) against EUR = ±0.96%

Reduced shock factors shall also apply between two currencies pegged to the euro (transitivity of shock factors). In this case,

the reduced shock factor for each pair of currencies pegged to the euro shall be:

– 2.66% when the local and foreign currencies are the DKK and the LTL;

– 3.45% when the local and foreign currencies are the DKK and the BGN;

– 2.5% when the local and foreign currencies are the DKK and the XOF;

– 2.5% when the local and foreign currencies are the DKK and the XAF;

– 3.37% when the local and foreign currencies are the DKK and the KMF;

– 1.3% when the local and foreign currencies are the LTL and the BGN;

– 0.38% when the local and foreign currencies are the LTL and the XOF;

– 0.38% when the local and foreign currencies are the LTL and the XAF;

– 1.22% when the local and foreign currencies are the LTL and the KMF;

– 1.15% when the local and foreign currencies are the BGN and the XOF;

– 1.15% when the local and foreign currencies are the BGN and the XAF;

– 2% when the local and foreign currencies are the BGN and the KMF;

– 0.22% when the local and foreign currencies are the XOF and the XAF;

– 1.07% when the local and foreign currencies are the XOF and the KMF;

– 1.07% when the local and foreign currencies are the XAF and the KMF.

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Mktconc = concentration risk

The underlying assumptions for the market risk concentration sub-module can be summarised as follows:

• Undertakings are only exposed to concentration risk regarding the accumulation of exposure with the same counterparty. The concentration risk sub- module does not include other types of concentration risks, such as geographical or sector concentrations of the assets held.

• Undertakings are at risk and a capital requirement is determined when accumulated single name exposures are above the

specified concentration thresholds. When accumulated single name exposures are below the specified thresholds, undertakings are not at risk, and no capital requirement for concentration risk is determined.

• The risk (volatility- VaR) of a badly diversified portfolio is higher than for a well diversified basket of investments. It is assumed that undertakings have a portfolio with an investment mix that does not deviate materially from an EU average undertakings’ portfolios of investments, i.e. it consists of significantly more bonds than equity.

• Undertakings' exposures in the form of covered bonds with high credit quality steps (0 or 1) are covered by a diversified pool of assets securing most of the bond’s value in case of a default of the issuer. Where covered bonds cannot be assigned to a high credit quality step (0 or 1) a higher concentration threshold is assumed to be not appropriate.

• A higher excess exposure threshold is assumed appropriate for captives in the concentration risk module, due to the fact that for captives the insured entities are part of the same group owning the captive. The concentration risk referring to the amounts between the two thresholds (i.e. 3% or 1.5% versus 15%) is entirely mitigated by the existence of explicit or implicit intragroup compensation mechanisms. Even without formal compensation mechanisms, the group (the owner and simultaneously insured party) has an interest in supporting the captive in case of financial or other problems of the captive.

79

Mktconc = concentration risk (cont)

• The scope of the concentration risk sub-module covers assets considered in the equity, spread and property risk modules and excludes assets covered by the counterparty default risk module.

• Covers risk regarding the accumulation of exposures from financial investments to the same counterparty (does not include other accumulations such as geographical or industry sector). Exposures to Groups as defined within the Solvency II and Financial Conglomerates Directive should be treated as one exposure.

• Module excludes the following assets:

a) assets held in respect of life insurance contracts where the investment risk is fully borne by the policy holders,

b) exposures to Group undertakings provided subject to the same risk evaluation, measurement and control procedures as the undertaking, is in the EU, and there are no current or foreseen material practical or legal impediment to the prompt transfer of own funds or repayment of liabilities from the counterparty to the undertaking,

c) the value of the participations as defined in Article 92(2) of Directive 2009/138/EC in financial and credit institutions that are deducted from own funds,

d) assets covered in the counterparty default risk module,

e) deferred tax assets,

f) intangible assets

• Where an undertaking has more than one exposure to a counterparty, the aggregate exposure should be calculated and the weighted average rating used in the concentration risk calculations. ratingi should be a weighted average credit quality step on this single name exposure, determined as the whole number nearest to the average of the credit quality steps of the individual exposures to this counterparty, weighted by the net exposure at default in respect of that exposure to this counterparty.

• Exposures via investment funds or such entities whose activity is mainly the holding and management of an undertaking’s own investment need to be considered on a look-through basis. The same holds for CDO tranches and similar investments embedded in ‘structured products’. The concentration risk module should not be applied at the level of an investment fund but at the level of each sub-counterparty, after aggregation of exposures to each sub-counterparty at the portfolio level. If the underlying single name exposures of the investment fund cannot be determined, the concentration risk should be applied at the level of the investment fund.

80

Mktconc = concentration risk (cont)

The calculation is performed in three steps: (1) excess exposure per single name exposure, (2) risk concentration capital requirement per single name exposure, (3) aggregation across single name exposures.

1) Excess exposure calculated as follows:

and the concentration threshold ( CT ) for a counterparty rating of i:

81

where Ei = Net exposure at default to counterparty I that is included in the calculation base of the market risk concentration sub-module. Assetsxl = Amount of total assets considered as calculation base in this sub-module. Ratingi = External rating of the counterparty i

ratingi CT

AA-AAA 3.0%

A 3.0%

BBB 1.5%

BB or lower 1.5%

}{0; xlii AssetsCTEmax XS

Mktconc = concentration risk (cont)

2) Risk concentration per “name” - The capital requirement for market risk concentration on a single name exposure i Conci shall be equal to the loss in the basic own funds that would result from an instantaneous decrease in the value of the assets corresponding to the single name exposure i equal to:

where the rating of g is as per the table:

For unrated (re)insurers

(the value of the risk factor

gi for market risk concentration

shall be linearly interpolated from

the solvency ratio and risk factor

values specified in the table)

For other single name exposures gi = 73%

For exposures to non-EEA governments & agencies:

82

XSi • gi ratingi gi

AAA 0.12

AA 0.12

A 0.21

BBB 0.27

BB or lower 0.73

ratingi g*i

AAA 0 AA 0 A 0.12

BBB 0.21 BB 0.27

B or lower, unrated

0.73

Solvency II Ratio

gi

196% 0.12

175% 0.21

122% 0.27

100% 0.645

95% 0.73

Mktconc = concentration risk (cont)

3) Aggregation between “names”

Capital charge then calculated assuming no correlation among the requirements for each counterparty i:

• `

• For covered bonds with AAA or AA credit rating, threshold of 15% applies.

• For directly and indirectly owned properties, undertakings shall identify the exposures in a single property higher than 10% cent of ‘total assets’ considered (incl government bonds) and a charge of XSi*0.12 applies.

• For single name exposures for which a credit assessment by a nominated ECAI is not available, which are credit institutions and financial institutions within the meaning of Article 4(1) and (5) of Directive 2006/48/EC and which meet the requirements of Directive 2006/48/EC shall be assigned a risk factor gi for market risk concentration of 64.5%.

• Bank deposits can be exempted to the extent their full value is covered by a government guarantee scheme in the EEA area, the guarantee is applicable unconditionally to the undertaking and provided there is no double-counting of such guarantee with any other element of the SCR calculation.

83

i

iconc ConcMkt 2

Counterparty Default Risk Module

• The counterparty default risk module should reflect possible losses due to unexpected default, or deterioration in the credit standing, of the counterparties and debtors of (re)insurance undertakings over the following 12 months. The counterparty default risk module shall cover risk-mitigating contracts, such as reinsurance arrangements, securitisations and derivatives, and receivables from intermediaries, as well as any other credit exposures which are not covered in the spread risk sub-module. It shall take appropriate account of collateral or other security held by or for the account of the insurance or reinsurance undertaking and the risks associated therewith. For each counterparty, the counterparty default risk module shall take account of the overall counterparty risk exposure of the insurer concerned to that counterparty, irrespective of the legal form of its contractual obligations to that undertaking.

• Different treatments of exposures to single name counterparties are deemed appropriate, depending on the degree of diversification of the portfolio to counterparties, their credit quality and whether counterparties are rated or not. Loss given default takes account of potential recovery of funds, risk adjusted value of collateral under the market risk stresses as well as the impact on underwriting and market risk due to ineffectiveness of risk mitigation under a default scenario.

• Where liabilities for employee benefits are recognised these should be taken into account in the calculation of the capital requirements for counterparty default risk and for the sub-modules in the market risk module. For this purpose, undertakings should take into account the nature of the benefits and where relevant, the nature of all contractual arrangements (e.g. if outsourced, counterparty default risk & market risk module).

• The capital requirement for securities lending arrangements and securities repurchase arrangements should follow the recognition of items exchanged in SII balance sheet, also consider contractual terms and risks stemming from the agreement.

84

• If a lent asset remains in the balance sheet, and the asset received is not recognized, the relevant market risk charges should be applied to the lent asset. In addition, a counterparty default risk charge (type 1 exposure) should apply to the lent asset, taking into account the risk-mitigation provided by the asset received if the latter is recognised as a collateral.

• If the lent asset does not remain on the balance sheet and the asset received is recognised, the relevant market risk charges should be applied to the asset received. In addition, if, following the contractual terms of the lending arrangement and the legal provisions applying in case of insolvency of the borrower, there is a risk that the lent asset is not given back to the lender at the end of the arrangement, although the received asset has been returned to the borrower, then a capital charge for counterparty default risk should be calculated, based on the initial value of the lent asset.

• In case where the lent asset and the asset received are both recognized on the balance sheet, the relevant market risk charges should be applied to both. In addition, a counterparty default risk charge should apply to the lent asset, taking into account the risk-mitigation provided by the asset received if the latter is recognized as a collateral.

• If the lending arrangement results in the creation of a liability on the balance sheet, the insurer should consider this liability when calculating the interest rate risk capital charge.

Counterparty Default Risk (cont)

• The underlying assumptions for the counterparty default risk sub-module can be summarised as follows: • For type 1 exposures, the LGD on counterparties that do not belong to the same group are independent and the LGD

on counterparties that belong to the same group are not independent. Exposures which are neither captured in the spread risk sub-module nor the counterparty default risk module as type 1 exposures should be captured as type 2 exposures within the counterparty default risk module. Default probabilities assume a shocked component and tail correlation between counterparty defaults to reach a 99.5% quantile of the loss distribution. This method assumes that the default probability of a given counterparty can vary significantly over time and there can be significant dependence between defaults at certain points in time. The recovery rates for risk mitigation techniques (reinsurance recoverables, derivatives and mortgages related to residential mortgage loans) are assumed to reflect best practices.

• For the simplified calculation of the risk mitigation effect it is assumed that there is no financial relationship between the counterparty and the insurance undertaking other than the risk mitigation technique. In particular, no net additional loss to the undertaking (in addition to the loss of the risk mitigation on the SCR per se) would occur following the default of the counterparty (e.g. no triggering of contingent liabilities).

• For the simplified calculation of the risk mitigation effect for reinsurance arrangements or securitisation it is assumed that there is no financial relationship between the counterparty and the insurance undertaking other than the risk mitigation technique. In particular, no net additional loss to the undertaking (in addition to the loss of the risk mitigation on the SCR per se) would occur following the default of the counterparty (e.g. no triggering of contingent liabilities).

• For the simplified calculation of the risk mitigation effect for proportional reinsurance arrangements, it is assumed that reinsurance programs provided to the undertaking by different counterparties are the similar in term of covers and limits and nature. It is also assumed that there is no financial relationship between the counterparty and the insurance undertaking other than the risk mitigation technique. In particular, no net additional loss to the undertaking (in addition to the loss of the risk mitigation on the SCR per se) would occur following the default of the counterparty (e.g. no triggering of contingent liabilities).

• For the simplified calculation of the risk adjusted value of collateral to take into account the economic effect of the collateral it is assumed that the collateral instrument is neither a reutilised collateral nor foreseen to be reutilized for other purposes. In addition, the market risk adjustment for the collateral is assumed lower than 15% of the market value and the collateral is of an asset class that is sufficiently diversified with regards to the asset portfolio of the undertaking.

85

Counterparty Default Risk (cont)

• Exposures shall be split into Type I and II as follows:

• The following credit risks are not covered: a) the credit risk transferred by a credit derivative; b) the credit risk on debt issuance by special purpose vehicles, whether as defined in Article 13(26) of Directive

2009/138/EC or not; c) the underwriting risk of credit and surety ship insurance or reinsurance. d) the credit risk on mortgage loans which do not meet the requirements for mortgage loans (see Art.105 (6) of Directive

2009/138/EC39). • Investment guarantees on insurance contracts provided to policy holders by a third party and for which the insurance or

reinsurance undertaking would be liable should the third party default shall be treated as derivatives in the counterparty default risk module. 86

TYPE I • Reinsurance arrangements (incl SPV),

securitisations and derivatives, & any other risk mitigating contracts. • Cash at bank, Deposits with ceding institutions, (if the no of parties does not > 15). • Capital, initial funds, Letters of Credit, other called up but are unpaid commitments (if the no of parties does not > 15). • Guarantees, Letters of Credit, Letters of Comfort & other such type commitments provided by undertaking.

TYPE II • Receivables from intermediaries. • Policyholder debtors. • Residential mortgage loans. • Deposits with ceding institutions, (if the no of parties > 15) • Capital, initial funds, Letters of Credit, other called up but unpaid commitments (if the no of parties > 15).

)5.12

def,2def,2def,1

2

def,1def SCRSCRSCR(SCRSCR

SCRdef,1= default risk type 1

• The main inputs of the counterparty default risk module for type I exposures are the estimated loss given default (LGD) of an exposure and the variance of the loss distribution (V).

• where the sum is taken over all independent counterparties with type 1 exposures and:

– LGDi = Loss given default for type 1 exposure of counterparty i. LGD is conceptually defined to be the loss of basic own funds which the (re)insurer would incur if the counterparty defaults.

– V = Variance of the loss distribution of the type 1 exposures.

– √V= Standard deviation of the loss distribution of the type 1 exposures.

• The variance of the loss distribution of type 1 exposures shall be equal to the sum of Vinter and Vintra.

– where (a) the sum covers all possible combinations (j,k) of different probabilities of default on single name exposures and (b) TLGDj and TLGDk denote the sum of losses given default on type 1 exposures from counterparties bearing a probability of default PDj and PDk respectively.

– where (a) the first sum covers all different probabilities of default on single name exposures, (b) the second sum covers all single name exposures that have a probability of default equal to PDj, (c) LGDi denotes the loss given default on the single name exposure i.

87

kj

kj kjjk

jjkk

er TLGDTLGDPDPDPDPD

PDPDPDPD

)(25.1

)1()1(V

,

int

PDj

i

j j

jj

raLDG

PD

PDPD 2

int 5.2

)1(5.1V

SCRdef,1= default risk type 1 (cont)

• Probability of Default determined by

– Ratings from nominated credit rating agency (ECAI) as follows:

– For (re)insurers who meet the MCR and calculate solvency as per technical specifications:

– In cases where more than one rating is available for a counterparty, use the 2nd highest rating. – For unrated counterparties, the probability of default should be 4.2%. – For banks who do not have a rating but are compliant CRD 2006/48/EC assume p(d) = 0.5%.

88

Rating i P i

AAA 0.00%

AA 0.01%

A 0.05%

BBB 0.24%

BB 1.20%

B 4.20%

CCC or lower 4.20%

Solvency PD Implied

Margin Rating

196% 0.01% <------ AA

175% 0.05% <------ A

150% 0.10%

125% 0.20%

122% 0.24% <------ BBB

100% 0.50%

95% 1.20% <------ BB

75% 4.20% <------ B

SCRdef,1= default risk type 1 (cont)

• Pooling arrangements - Undertakings may consider exposures which belong to different members of the same legal or contractual pooling arrangement as different single name exposures, irrespective of whether the undertaking ceding its risk to the pool is a member of the pool or not.

• A “pooling arrangement" is an arrangement between several insurance or reinsurance undertakings, the “pool members”, whereby the pool members agree to share in defined proportions similarly defined insurance risks each pool member has written for its own account. The pool members are jointly liable or severally liable for the insurance risks transferred to the pooling arrangement. For the purpose of this definition:

- the parties insured by the members of the pooling arrangement are not themselves members of the pooling arrangement.

- a contract including the parties insured as a member to the contract is not a pooling arrangement.

• The technical specifications outlines 3 types of pooling arrangements and the applicable LGD for each.

89

Type A Type B Type C

SCRdef,1= default risk type 1 (cont)

• Loss Given Default (LGD) for risk mitigating contracts: The LGD of an exposure is conceptually defined to be the loss of basic own funds which the insurer would incur if the counterparty defaulted.

– For reinsurance arrangements (including issued by SPV):

• RRre = Recovery rate = 50% (unless reinsurer has > 60% of its BS tied up in collateral, then 10%). • Recoverablesi = Best estimate recoverables from arrangement i plus any other debtors arising from

arrangement. • RMre,i = Risk mitigating effect on underwriting risk of the reinsurance or SPV securitisation i. • Collaterali = Risk adjusted value of collateral in relation to the reinsurance or SPV securitisation i. • F= Factor to take into account the economic effect of the collateral arrangement in relation to the reinsurance

arrangement or securitisation in case of any credit event related to the counterparty i.

– For derivative:

• RRfin = Recovery rate, set at 10%. • MarketValuei = Value of the derivative i according to Article 75. • RMfin,i = Risk mitigating effect on market risk of the derivative i. • Collaterali = Market value of collateral in relation to the derivative i. • F= Factor for collateral.

– For mortgage loan:

• Loani = Value of the mortgage loan i in accordance with Article 75 of Directive. • Mortgagei = Risk-adjusted value of the mortgage in relation to the mortgage loan i, risk adjusted based upon the

difference between the hypothetical capital for market risk for property with and without the mortgage.

90

);0))CollateralRMles(Recoverab)RRmax((1LGD iire,irei *)*50.0 F

);0))CollateralRMue(MarketVal)RRmax((1LGD iifin,ifini *F

;0)MortgageMax(LoanLGD iii

SCRdef,1= default risk type 1 (cont)

• Loss Given Default (LGD) for risk mitigating contracts – Risk Mitigating (RM) effect – Risk mitigating effect RMre,i and RMfin,i are defined as the difference between SCRhyp and SCRwithout where:

• SCRhyp = Underwriting and market risk gross of risk mitigating effect. • SCRwithout = Underwriting and market risk without any amendments.

– For non-life reinsurance (for each LOB, sum the SCR difference for each LOB to get the aggregate):

where

= Counterparty’s share of CAT losses. = Reinsurance premium of the counterparty in the affected line of business. recoverables = Reinsurance recoverables in relation to the counterparty in the affected line of business. σ (prem,lob) = SD

for premium risk in the affected LOB as used in the premium and reserve risk sub-module. σ(res,lob) = SD for reserve risk in the affected LOB as used in the premium and reserve risk sub-module

– Risk mitigating effect RMre,i for a reinsurance arrangement (that offers combined underwriting and market risk transfer)

is given by an aggregation (assuming 0.25 correlation) of the differences between gross SCR and the net SCR for underwriting and market risk, as follows:

91

esrecoverablσPP9σ

esrecoverabl3σPP3σNLNL

lobres,withoutlob

hyploblobprem,

2

lobres,

2withoutlob

hyploblobprem,

2withoutcat

hypcat

)2

RMRMRM.2

(RMRMmkti,re,mkti,re,u/wi,re,u/wi,re,

ire, 2502

withoutcat

hypcat NLNL

withoutlob

hyplob PP

SCRdef,1= default risk type 1 (cont)

• Loss Given Default (LGD) for risk mitigating contracts – Risk Mitigating (RM) effect (cont) – For life reinsurance and derivatives, the calculation of SCRhyp and SCRwithout should be determined whereby the risk

mitigating contract provides no compensation for the scenarios being tested. – For cash at bank, deposits with ceding institutions and unpaid but called up capital or for receivables from

intermediaries or policyholder debtors the loss-given-default should be the value of the corresponding asset in accordance with Article 75 of the Directive.

– For guarantees, letters of credit, letters of comfort and other commitment which depend on the credit standing of a counterparty the loss-given default should be the difference between their nominal value and their value in accordance with Article 75 of the Directive.

– If in relation to a counterparty more than one type 1 exposures exist, then the loss-given-default for this counterparty should be the sum of the losses-given-default of the single exposures assignment.

92

SCRdef,1= default risk type 1 (cont)

• Loss Given Default (LGD) for risk mitigating contracts – Simplified calculations of RM Effects – Simplifications can only be used where:

• No indications that simplifications significantly underestimates the risk mitigating effect. • The results of the sophisticated calculation is not easily available.

– Risk mitigating effect is the difference between SCRhyp and SCRwithout where SCRhyp = Underwriting and market risk gross of risk mitigating effect and SCRwithout = Underwriting and market risk without any amendments.

– Reinsurance and SPV: risk-mitigating effect on underwriting risk of a reinsurance arrangement or securitisation may be calculated

• Step 1 – Calculate SCRnlhyp – SCRnl

without for all reinsurance counterparties together. • Step 2 – Approximate the share of a single counterparty i where Reci is the reinsurance recoverable for i and

Rectotal is the total recoverables.

– For Proportional Reinsurance: the risk-mitigating effect on underwriting risk j of a proportional reinsurance arrangement from counterparty i where BE means the best estimate of the gross reserves and SCRj denotes the capital requirements for underwriting risk j of the insurance or reinsurance undertaking may be calculated as follows:

93

total

iwithoutnl

hypnli

withoutnl

hypnl

Rec

RecSCRSCRSCRSCR

total

ij

Rec - BE

RecSCR

SCRdef,2= default risk type 2

• The counterparty default risk shock on type 2 exposures is the immediate effect on the net value of asset and liabilities expected in the event of a fall in the value of the type 2 exposures as follows:

where

– LGDreceivables>3months denote the total losses-given-default on all receivables from intermediaries which have been due for more than three months.

– LGDi denotes the loss-given-default on the type2 exposure i other than receivables from intermediaries which have been due for more than three months.

• Retail loans secured by mortgages on residential property (mortgage loans) shall be treated as type 2 exposures under the

counterparty default risk provided the following requirements are met: (1) The exposure shall be either to a natural person or persons or to a small or medium sized enterprise. (2) The exposure shall be one of a significant number of exposures with similar characteristics such that the risks associated

with such lending are substantially reduced. (3) The total amount owed to the (re)insurer shall not exceed EUR 1 million. (4) The residential property is or shall be occupied or let by the owner. (5) The value of the property does not materially depend upon the credit quality of the borrower. (6) The risk of the borrower does not materially depend upon the performance of the underlying property, but on the

underlying capacity of the borrower to repay the debt from other sources, and as a consequence, the repayment of the facility does not materially depend on any cash flow generated by the underlying property serving as collateral. For those other sources, the insurance or reinsurance undertaking shall determine maximum loan-to-income ratio as part of their lending policy and obtain suitable evidence of the relevant income when granting the loan.

(7) The mortgage charge is enforceable in all relevant jurisdictions, all legal requirements for establishing the pledge have been fulfilled, and the legal process of the jurisdiction will enable the (re)insurer to enforce its rights within a reasonable timeframe.

94

months 3sreceivabledef,2 0.9SCR LDGLDG15.0i

i

SCRdef & Collaterals

• A 'collateral arrangement' means an arrangement under which either: (a) a collateral provider transfers full ownership of the collateral to the collateral taker for the purpose of securing or

otherwise covering the performance of a relevant obligation; or (b) a collateral provider provides collateral by way of security in favour of, or to, a collateral taker, and the legal ownership of

the collateral remains with the collateral provider or a custodian when the security right is established. • The loss-given-default (in case of a type 1 exposure) or the value of the exposure (in case of a type 2 exposure) may be reduced

by the risk-adjusted value of the collateral if: – The legal mechanism by which collateral is pledged or transferred should ensure that the undertaking has the right to

liquidate or take legal possession of the collateral, in a timely manner, in case of any default event related to the counterparty ("the counterparty requirement")

– Where applicable, the legal mechanism by which collateral is pledged or transferred should ensure that the undertaking has the right to liquidate or take possession of the collateral, in a timely manner, in case of any default event related to a 3rd party custodian holding the collateral ("the custodian requirement")

• If both conditions met, then A% = 100%, if only counterparty requirement met, then A% = 90%, If counterparty requirement not met, then A% = 0%.

• A simplification may be applied, where X% = 75% where only counterparty requirement met or X% = 85% if both requirements met, as follows:

• The use of letter of credits (LOCs) may be taken into account and the LOC provider may be used to replace the counterparty if the conditions for financial risk mitigation are met. A LOC should not be taken into account in the calculation of the counterparty default risk module if it is classified as ancillary own funds.

• Where the requirements on financial risk mitigation techniques are met, the segregated assets should be treated like collaterals in the calculation of the counterparty default risk module.

• Where the requirements on financial and insurance risk mitigation techniques are met, the LGD (in case of a type 1 exposure) or the value of the exposure (in case of a type 2 exposure) may be netted with liabilities towards the same legal entity to the extent they could be set off in case of default of the legal entity. In particular, if the legal situation in relation to netting is unclear, then no netting should be taken into account. No netting should be allowed for if the liabilities are expected to be met before the credit exposure is cleared.

95

CollateralueMartketValX %Collateral

CollateralCollateral MktRiskeMarketValuA%Collateral

Life Underwriting Risk Module Life underwriting risk module covers the risk arising from the underwriting of life insurance, associated with both the perils covered and the processes followed in the conduct of the business. It shall be calculated as a combination of the capital requirements for at least the following sub-modules:

(a) the risk of loss, or of adverse change in the value of insurance liabilities, resulting from changes in the level, trend, or volatility of mortality rates, where an increase in the mortality rate leads to an increase in the value of insurance liabilities (mortality risk);

(b) the risk of loss, or of adverse change in the value of insurance liabilities, resulting from changes in the level, trend, or volatility of mortality rates, where a decrease in the mortality rate leads to an increase in the value of insurance liabilities (longevity risk);

(c) the risk of loss, or of adverse change in the value of insurance liabilities, resulting from changes in the level, trend or volatility of disability, sickness and morbidity rates (disability – morbidity risk);

(d) the risk of loss, or of adverse change in the value of insurance liabilities, resulting from changes in the level, trend, or volatility of the expenses incurred in servicing insurance or reinsurance contracts (life-expense risk);

(e) the risk of loss, or of adverse change in the value of insurance liabilities, resulting from fluctuations in the level, trend, or volatility of the revision rates applied to annuities, due to changes in the legal environment or in the state of health of the person insured (revision risk);

(f) the risk of loss, or of adverse change in the value of insurance liabilities, resulting from changes in the level or volatility of the rates of policy lapses, terminations, renewals and surrenders (lapse risk);

(g) the risk of loss, or of adverse change in the value of insurance liabilities, resulting from the significant uncertainty of pricing and provisioning assumptions related to extreme or irregular events (life-catastrophe risk).

96

SCRSCRLifeLife

LifeMortality

LifeLongevity

LifeDisability

LifeLapse

LifeExpense

LifeRevision

LifeCAT

Life Underwriting Risk (cont)

The underlying assumptions for the Life underwriting risk module can be summarised as follows:

• The calibration of the Life underwriting risk parameters captures changes in the level and trend of the parameter. It is assumed that the volatility risk component is implicitly covered by the level, trend and catastrophe risk components. This is considered to be acceptable, since volatility risk is thought to be considerably lower than the trend risk.

• The dependence of benefit payments on inflation is not material.

• The insurance portfolios is well diversified with respect to: age, gender, smoker status, socio economic class, level of life insurance cover, type of insurance cover, degree of underwriting applied at inception of the cover and geographical location.

• For mortality, longevity, disability/morbidity, expenses and revision risk, the calibration regarded of great importance a study by Watson Wyatt, published in 2004. The study analysed the 99.5% assumptions over a 12 month time horizon that firms were proposing to make for their Individual Capital Assessments (ICAS) submissions in the UK.

97

Life Underwriting Risk (cont)

The life underwriting risk is split into 7 risks:

• Lifemort = Capital charge for mortality risk

• Lifelong = Capital charge for longevity risk

• Lifedis = Capital charge for disability risk

• Lifelapse = Capital charge for lapse risk

• Lifeexp = Capital charge for expense risk

• Liferev = Capital charge for revision risk

• LifeCAT = Capital charge for CAT

where CorrUL is:

98

rxc crcr,life LifeLifeCorrULSCR

Mortality Longevity Disability Lapse Expenses Revision CAT

Mortality 1

Longevity -0.25 1

Disability 0.25 0 1

Lapse 0 0.25 0 1

Expenses 0.25 0.25 0.5 0.5 1

Revision 0 0.25 0 0 0.5 1

CAT 0.25 0 0.25 0.25 0.25 0 1

Lifemort= Mortality

1) Lifemort mortality risk - Mortality risk is the risk of loss, or of adverse change in the value of insurance liabilities, resulting from changes in the level, trend, or volatility of mortality rates, where an increase in the mortality rate leads to an increase in the value of insurance liabilities.

where the change in the value of basic own funds (not including changes in the risk margin of technical provisions) from a mortshock = a (permanent) 15% increase in mortality rates used in calculating the technical provisions for each age and each policy where the payment of benefits (either lump sum or multiple payments) is contingent on mortality risk.

– Subject to certain preconditions (i.e. simplification is proportionate to the nature, scale and complexity of the risks and standard calculation is an undue burden for the undertaking), a simplification may be used as follows:

where • CAR denotes the total positive capital at risk, meaning the sum, in relation to each contract, of the higher of

zero and the difference between the following amounts: (i) the sum of the amount that the (re)insurer would currently pay in the event of the death of the

persons insured under the contracts (net of reinsurance & SPV) and the expected PV of future amounts that the (re)insurer would pay under the same contracts (again net of reinsurance and/or SPV).

(ii) the best estimate of the corresponding obligations after deduction of the amounts recoverable from reinsurance and/or SPV.

• q is an undertaking-specific expected average mortality rate for the next year weighted by sum assured. • n denotes the modified duration in years of payments payable on death included in the best estimate. • ik denotes the annualized spot rate for maturity k of the relevant risk-free term structure.

99

i

mortshockmort ΔBOFLife

n

kk

k

i

qqCAR

1

5.0

1

1)(15.0mortalitySCR

Lifemort= Mortality (cont)

Lifemort mortality risk – Background & assumptions to calibration The stress factor for mortality risk reflects the uncertainty in mortality parameters as a result of mis-estimation and/or changes in the level, trend and volatility of mortality rates and captures the risk that more policyholders than anticipated die during the policy term. The underlying assumptions for the mortality risk sub-module can be summarised as follows: • The undertaking has established a system to restrict adverse selection. • The probability distribution for mortality is skewed, with a current trend towards improving mortality. • For the simplified calculation of the capital requirement for mortality risk it is assumed that there is no material

decrease in the respective sum of capital at risk in the next n years, where n is the modified duration (in years) of payments payable on death included in the best estimate projection. It is furthermore assumed, that the average mortality rate of the insured persons (weighted by sum insured) will not increase materially over the next n years.

• The calibration for mortality risk has varied during the standard formula calibration process before arriving at the current 15%. For example, 20% was used in QIS2 and 10% in QIS3.

• Commentary following QIS4: QIS4 feedback on the calibration of the mortality stress was varied. However an analysis of the mortality stress parameters provided by firms using internal models indicated that the standard formula parameter was relatively low. Based on a sample size of 21 internal models, the median stress was 22%, with an inter quartile range of13% to 29%. This is significantly higher than the standard formula calibration of 10%. CEIOPS therefore proposes to amend the calibration of the mortality stress to a permanent increase in mortality rates of 15%.

• Commentary on QIS3: For mortality risk, we had regard to information derived from a study published in 2004 by Watson Wyatt about the 99.5% assumptions over a 12 months time horizon that firms were proposing to make for their ICAS submissions in the UK. This indicated a range of between 10% and 35%, with an average of around 23%. However, it is thought that this assumption may cover both trend and volatility risk, as well as possibly cat risk. More recent ICAS submissions are believed to have included a fairly low level of mortality trend shock. This may reflect the likelihood that the probability distribution for mortality is skewed, with a current trend towards improving mortality. It is also relevant to note that many firms may not allow explicitly for future improvements when assessing the best estimate mortality rates for insured lives.

100

Lifelong= Longevity

2) Lifelong longevity risk - The longevity risk is associated with the risk of loss, or of adverse change in the value of insurance liabilities, resulting from changes in the level, trend, or volatility of mortality rates, where a decrease in the mortality rate leads to an increase in the value of insurance liabilities.

where the change in the value of basic own funds (not including changes in the risk margin of technical provisions) from a

lonevityshock = a (permanent) 20% decrease in mortality rates used in calculating the technical provisions for each age and each policy where the payment of benefits (either lump sum or multiple payments) is contingent on longevity risk. • The longevity scenario should be calculated under the condition that the scenario does not change the value of future

discretionary benefits in technical provisions. • The stress factor for longevity risk is intended to reflect the uncertainty in mortality parameters as a result of mis-

estimation and/or changes in the level, trend and volatility of mortality rates and captures the risk of policyholders living longer than anticipated. The underlying assumptions for the longevity risk sub-module can be summarised as follows:

• The annual mortality improvements follow a normal distribution. • For the simplified calculation of the capital requirement for longevity risk it is assumed that the average age of

policyholders within the portfolio is 60 years or more. • It is furthermore assumed that the average mortality rate of the respective insured persons does not increase

by more than 10% each year. – Subject to certain preconditions (i.e. simplification is proportionate to the nature, scale and complexity of the risks and

standard calculation is an undue burden for the undertaking), a simplification may be used as follows:

where with respect to the policies contingent on longevity risk; • BElong is the best estimate for contracts subject to longevity risk, • q is an undertaking-specific expected average death rate for the next year weighted by sum assured. • n denotes the modified duration in years of the annuity payments to beneficiaries included in the best estimate.

101

i

hocklongevityslong ΔBOFLife

longBEnq n 2/)1(1.12.0longevitySCR

Lifedis= Disability Risk 3) Lifedis disability risk - Disability-morbidity risk is the risk of loss, or of adverse changes in the value of insurance liabilities, resulting from changes in the level, trend or volatility of disability and morbidity rates.

where the change in BOF (excluding risk margin) from disshock = an increase of 35% in morbidity/disability inception rates for the

first year, together with a (permanent) 25% increase (over best estimate) in morbidity/disability inception rates at each age in following years. Plus, where applicable, a permanent decrease of 20% in morbidity/disability recovery rates across all years.

• The stress factors for disability/morbidity risk reflect the risk that more policyholders than anticipated become disabled or sick during the policy term (inception risk), and that disabled people recover less than expected (recovery risk). The underlying assumption for the disability/morbidity risk is that the insurance portfolio is well diversified in terms of likelihood of disability or sickness (inception rates) or change in the severity of disability or sickness (recovery rate).

• Subject to certain preconditions (i.e. simplification is proportionate to the nature, scale and complexity of the risks and standard calculation is an undue burden for the undertaking), a simplification may be used. For the simplified calculation of the capital requirement for disability/morbidity risk it is assumed that there is no material decrease in the respective sum of capital at risk in the next n-1 years after the following year, where n is the modified duration (in years) of payments payable on disability/morbidity included in the best estimate projection. It is furthermore assumed, that the expected average disability/morbidity rate of insured persons (weighted by the sum insured) will not increase materially during that period. Finally, it is also assumed that the expected average disability/morbidity rate and the expected termination rates do not increase by more than 10% each year. Simplification as follows:

where

• CAR1 and CAR2 denote the capital at risk (calculated as per mortality) for disability-morbidity exposures during the following 12 months and the exposed period after the following 12 months.

• d1 and d2 denote the expected average disability-morbidity rate during the following 12 months and the period thereafter respectively weighted by the sum insured.

• BEdis is the best estimate for contracts subject to disability and morbidity risk. • t denotes the expected termination rates during the following 12 months. • N denotes the modified duration in years of the disability/morbidity payments to beneficiaries included in the best

estimate. 102

i

disshockdis ΔBOFLife

Lifedis = (CAR1●d1●0.35) + (CAR2●d2●0.25●(n-1)●(1.1)((n-3)/2)) + BEdis●t●n●0.2●(1.1)((n-1)/2)

Lifelapse = Lapse risk

4) Lifelapse lapse risk - Lapse risk is the risk of loss or adverse change in liabilities due to a change in the expected exercise rates of policyholder options. The relevant options are all legal or contractual policy holder rights to fully or partly terminate, surrender, decrease, restrict or suspend insurance cover or permit the insurance policy to lapse. Where a right allows the full or partial establishment, renewal, increase, extension or resumption of insurance or reinsurance cover, the change in the option exercise rate shall be applied to the rate that the right is not exercised. In relation to reinsurance contracts the relevant policyholder options shall cover:

(a) the rights of the policyholders of the reinsurance contracts;

(b) the rights of the policyholders of the insurance contracts underlying the reinsurance contracts;

(c) where the reinsurance contracts covers insurance or reinsurance contracts that will be written in the future, the right of the potential policy holders not to conclude those insurance or reinsurance contracts.

• For the purpose of determining the loss in basic own funds of the (re)insurance undertaking under the lapse stresses, the undertaking shall base the calculation on the type of discontinuance which most negatively affects the basic own funds of the undertaking on a per policy basis.

• The underlying assumptions for the lapse risk sub-module can be summarised as follows:

• The increase and the decrease of lapse rates, is a symmetrical stress for the scenarios of increase and decrease of lapse rates (not the mass lapse event).

• The risk relating to the options that a ceding insurance or reinsurance undertaking of a reinsurance contract can exercise is not material.

• A split between insurance policies falling or not within the scope of management of group pension funds in the mass lapse event shock is assumed appropriate. This is due to the fact that for management of group pension funds, the risk of a mass lapse is deemed to be substantially greater because there are generally no surrender penalties, and institutional investors tend to be better informed and therefore would be quick to withdraw funds if there was any question over the solvency of a firm.

• For the simplified calculation of the capital requirement for life lapse risk the following is assumed: the simplified calculation is done at an appropriate granularity, such that the group of policies to which the method is applied is homogeneous in terms of lapse rate; the lapse rates are not significantly sensitive to trends in economic variables; the lapse rates do not vary significantly with the age of the policyholder; and the capital requirement for life lapse risk determined with the simplification is not material compared to the overall capital requirement.

103

Lifelapse = Lapse risk (cont)

4) Lifelapse lapse risk - Lapse risk is the risk of loss or adverse change in liabilities due to a change in the expected exercise rates of policyholder options.

Lifelapse = Capital requirement for lapse risk and nLifelapse = Capital requirement for lapse risk including the loss-absorbing capacity of technical provisions (wherever a term is preceded by a “n” it refers to the item including the loss-absorbing capacity of technical provisions).

lapseshockdown = Instantaneous permanent decrease of 50% in the assumed option exercise rates of the relevant options in all future years. However, the resulting decreased option exercise rates, following the application of the instantaneous permanent decrease of 50%, shall not exceed 20%.

lapseshockup = Instantaneous permanent increase of 50% in the assumed option exercise rates of the relevant options in all future years. However, the resulting increased option exercise rates (expressed as percentages), following the application of the instantaneous permanent increase of 50%, shall not exceed 100%.

104

masslapsemasslapse

uplapseuplapse

upmassupdown

downlapsedownlapse

downmassupdown

nLapsenLife LapseLife

nLapsenLife LapseLife

nLapse)nLapse;nLapse;max(nLapse

nLapsenLife LapseLife

nLapse)nLapse;nLapse;max(nLapse

andOtherwise

andthen

If

andthen

If

20%)-R R;min(150%(R)Rup

100%) R;max(50%(R)Rdown

Lifelapse = Lapse risk (cont)

4) Lifelapse lapse risk

lapseshockmass = The combination of the following instantaneous changes where 'discontinuance' means surrender, lapse without value, making a contract paid-up, automatic non-forfeiture provisions or exercising other discontinuity options or not exercising continuity options.

» the discontinuance of 70% of the insurance policies relating to group pension business for which discontinuance would result in an increase of technical provisions without the risk margin and where the policy holder is either not a natural person and discontinuance is not subject to approval by beneficiaries or a natural person acting for the benefit of the beneficiaries.

» the discontinuance of 40% of the insurance policies other than group pensions above and for which discontinuance would result in an increase of technical provisions without the risk margin.

» where reinsurance contracts cover insurance or reinsurance contracts that will be written in the future, the decrease of 40% of the number of those future insurance or reinsurance contracts used in the calculation of technical provisions.

A simplification for the down and up shock may apply under certain circumstances at the level of homogeneous risk groups instead of a policy-by-policy basis, as follows:

ldown;lup = estimate of the average rate of lapsation of the policies with a negative/positive surrender strain, subject to a minimum rate of lapsation of 40% in case of negative surrender strain and a minimum of 67% in case of positive surrender strain.

ndown;nup = average run-off (in years), weighted by surrender strains.

Sdown;Sup = sum of negative/positive surrender strains.

105

upupupup

downdowndowndown

Snl%Lapse

Snl%Lapse

50

50

Lifeexp = Expenses

5) Lifeexp expense risk - Expense risk arises from the variation in the expenses incurred in servicing insurance and reinsurance contracts.

where expshock = an increase of 10% in future expenses compared to best estimate anticipations, and increase by 1% per

annum of the expense inflation rate compared to anticipations. The underlying assumptions for the expense risk sub-module can be summarised as follows:

• Undertakings are exposed to the risk of the change of expenses arising predominantly from: staff costs, cost of commissions to sales intermediaries (on the basis of the contractual terms of the arrangements), cost of IT infrastructure, cost of land and buildings occupied.

• The undertaking operates in a macroeconomic environment where inflation, though subject to fluctuations, is broadly under control (i.e. inflation targeting).

• For the simplified calculation of the capital requirement for expense risk it is assumed that there is no material increase due

to other sources than inflation in the expenses incurred in servicing life insurance obligations, and where the projected cashflows follow a certain pattern. A simplification can be used where it is proportionate to the nature, scale and complexity of the risks that the undertaking faces and the expense risk sub-module is an undue burden for the undertaking.

• EI denotes the amount of expenses incurred in servicing life insurance or reinsurance obligations other than health insurance and reinsurance obligations during the last year.

• n denotes the modified duration in years of the cash-flows included in the best estimate of those obligations. • i denotes the weighted average inflation rate included in the calculation of the best estimate of those obligations,

weighted by the present value of expenses included in the calculation of the best estimate for servicing existing life obligations.

106

expshockexp |ΔNAVLife

Liferev = Revision

6) Liferev revision risk - Revision risk is the risk of loss, or of adverse change in the value of insurance and reinsurance liabilities, resulting from fluctuations in the level, trend, or volatility of revision rates applied to annuities, due to changes in the legal environment or in the state of health of the person insured.

where revisionshock = an increase of 3% in the annual amount payable for annuities exposed to revision risk over the run-off

period of the annuities.

• This risk module should be applied only to annuities where the benefits payable under the underlying insurance policies could increase as a result of changes in the legal environment or in the state of health of the person insured.

• This includes annuities arising from non-life claims (excluding annuities arising from health obligations which are treated in the health SLT module) where the amount of the annuity may be revised during the next year for the reasons mentioned above.

• The underlying assumptions for the revision risk sub-module can be summarised as follows: • All annuities are independent and their annual amount is assumed to be constant. • The average sized portfolio comprising annuities at different legal stages is in ‘average’ proportions.

• The calibration for revision risk was based on historical data for pensions in payment for the workers’ compensation line of business in Portugal.

• In the analysis a binomial compound distribution was fitted to the historical data, assuming a binomial distribution for the frequency process and a lognormal distribution to model the severity of revision. The aggregate loss distribution was derived using Monte Carlo simulation for different portfolio sizes. All annuities were assumed to be independent and their annual amount was assumed to be constant. Different assumptions were considered for annuities homologated and annuities not yet defined; the latter with higher frequency and severity volatilities.

107

ockrevisionshrev |ΔNAVLife

Lifecat = Catastrophe Risk

7) Lifecat catastrophe risk - Catastrophe risk stems from extreme or irregular events whose effects are not sufficiently captured in the other life underwriting risk sub-modules. Examples could be a pandemic event or a nuclear explosion.

where lifecatshock = an absolute 1.5 per mille increase in the rate of policyholders dying over the following year. Also assess

whether scenarios in health module apply and, if so, apply these scenarios in addition to the 1.5 per mille. • The life catastrophe risk sub-module captures the risk stemming from extreme death events that are not sufficiently captured

by the mortality risk sub- module. The underlying assumptions for the life catastrophe risk sub-module can be summarised as follows: • Life catastrophe risk is restricted to obligations that are contingent on mortality i.e. where an increase in mortality leads

to an increase in technical provisions. • The sub-module is assumed not to be applicable to obligations, such as annuities, where the increase in mortality leads

to a reduction in technical provisions. • For the simplified calculation of the capital requirement for catastrophe risk it is assumed that the capital at risk is an

appropriate proxy for the instantaneous loss caused by the death of the person insured by the respective contract.

• The calibration of the mortality catastrophe stress is based on a study carried out by Swiss Re in 2007, which estimated that the 1 in 200 year pandemic stress for most developed countries is between 1.0 and 1.5 per mille within insured lives. This study was based on a sophisticated epidemiological model, but had a number of weaknesses (such as not adequately allowing for the probability of flu jumping across species, not allowing for non-influenza pandemics as AIDS, drug resistant TB and the Ebola virus, not allowing for catastrophe due to terrorism or earthquakes, and so on). If these weaknesses were addressed, it is likely that the estimated stress would increase.

108

cklifecatshocat |ΔNAVLife

Lifecat = Catastrophe Risk (cont)

• A simplification may be used if it is proportionate to the nature, scale and complexity of the risks that the undertaking faces and the standard calculation of the catastrophe risk sub-module is an undue burden for the undertaking, as follows:

where:

(a) the sum includes all policies with a positive capital at risk; and

(b) CARi denotes the capital at risk of the policy i, meaning the higher of zero and the difference between the following amounts:

(i) the sum of:

- the amount that the insurance or reinsurance undertaking would currently pay in the event of the death of the persons insured under the contract after deduction of the amounts recoverable from reinsurance contracts and special purpose vehicles, and

- the expected present value of amounts not covered in the previous indent that the undertaking would pay in the future in the event of the immediate death of the persons insured under the contract after deduction of the amounts recoverable from reinsurance contracts and special purpose vehicles.

(ii) the best estimate of the corresponding obligations after deduction of the amounts recoverable form reinsurance contracts and special purpose vehicles.

109

i

CAT risk_at_Capital*.Life 00150

Non-Life Underwriting Risk Module

110

SCRSCRnonnon--lifelife

NLLapse

NLPremium&reserves

NLCAT

Other

Man Made

XoL Property Re

NatCAT

The non-life underwriting risk - Risk arising from non-life insurance obligations, in relation to the perils covered and the processes used in the conduct of business. It shall take account of the uncertainty in the results of (re)insurers related to the existing insurance obligations as well as to the new business expected to be written over the following 12 months. It shall be calculated as a combination of capital for at least the 3 sub-modules: • the risk of loss, or of adverse change in the value of insurance liabilities, resulting from fluctuations in the timing, frequency and severity of insured events, and in the timing and amount of claim settlements (non-life premium and reserve risk). • the risk of loss, or of adverse change in the value of insurance liabilities, resulting from uncertainty included in assumptions about exercise of policyholder options like renewal or termination options (lapse risk). • the risk of loss, or of adverse change in the value of insurance liabilities, resulting from significant uncertainty of pricing and provisioning assumptions related to extreme or exceptional events (non-life catastrophe risk).

SCRnl = Non-Life Underwriting Risk

• Non-life underwriting risk is the specific insurance risk arising from insurance contracts and relates to the uncertainty about the results of the (re)insurer’s underwriting, including amount and timing of claim settlements, volume of business & premium rates written, technical premium rates needed, and policyholder behaviour.

• The non-life underwriting risk module takes account of the uncertainty in the results of undertakings related to existing insurance and reinsurance obligations as well as to the new business expected to be written over the following 12 months.

• Calculated using correlations as follows:

where

111

rxc cr

rxcnl NLNLCorrNLSCR

CorrNL NLpr NLlapse NLCAT

NLpr 1

NLlapse 0 1

NLCAT 0.25 0 1

NLpr = Capital requirement for non-life premium and reserve risk NLlapse = Capital requirement for non-life lapse risk NLCAT = Capital requirement for non-life catastrophe risk

NLpr = premium & reserve risk • The non-life premium and reserve risk sub-module only takes into account losses that occur at a regular frequency. Extreme

events, which occur very rarely, have not been taken into account when calibrating the premium and reserve risk factors. Such extreme events should be taken into account in the catastrophe risk sub-module. The capital requirement also takes into account risk associated with new business expected to be written in the following 12 months.

• The underlying assumptions for the non-life premium and reserve risk sub-module can be summarized as follows: • The risk of an accumulation of a large number of similar claims that are covered by third party liability insurance

obligations is not material. • The underlying risk follows a lognormal distribution. • Complex relationships between different risks that could give rise to dependencies in the risk profile are implicitly

taken into account in the correlation parameters between the segments, lines of business and between premium and reserve risk for each line of business.

• The final factors are reflective of the average size and performance of the portfolios of insurers in the European market.

• Net earned premium can be used as a proxy for premium risk exposure. • Net provisions for claims outstanding can be used as a proxy for reserve risk exposure. • Expenses are not evolving independently or in an opposite way from the underlying risk over time. • Non-proportional reinsurance reduces the premium risk volatility by 20% in the segments 1, 4 and 5 (see Appendix 3).

No reduction is allowed for other segments in case Undertaking Specific Parameters are not used. • For the use of a simplified calculation of the capital requirement for non-life premium and reserve risk for captives it is

assumed that the segmentation of insurance obligations by captives can be considered materially less diversified in terms of lines of business compared to the portfolio used in the calibration of the standard formula.

• In the design of the geographical diversification coefficient adjusting the volume measure for non-life premium and reserve risk, it is assumed that geographically diversified portfolios are diversified in respect of size and timing of losses which an insurance undertaking faces.

112

NLpr = premium & reserve risk (cont) • Premium risk results from fluctuations in the timing, frequency and severity of insured events. Premium risk relates to

policies to be written (including renewals) during the period, and to unexpired risks on existing contracts. Premium risk includes the risk that premium provisions turn out to be insufficient to compensate claims or need to be increased. Premium risk also includes the risk resulting from the volatility of expense payments. Expense risk can be quite material for some segments and should therefore be fully reflected in the module calculations. Expense risk is implicitly included as part of the premium risk.

• Reserve risk results from fluctuations in the timing and amount of claim settlements.

• Capital charge for the premium and risk charge:

where

V = Volume.

σ = Combined standard deviation for premium and reserve risks.

p(σ) = The function of the standard deviation is set such that, assuming a lognormal distribution of the underlying risk, a risk capital charge consistent with the VaR 99.5% standard is produced. This approximates to p(σ) ≈ 3 • σ which can be used in the preparatory phase.

113

V NL pr ) ( s r

11

))1log(exp()(

2

2

995.0

s

ssr

N

NLpr = premium & reserve risk (cont)

– For each line of business (LOB), as per table on the right, the standard deviation and volume measure for both premium and reserve risks are determined.

– The standard deviation and volume measures for each LOB are aggregated to determine V and σ.

– Volume measure for premium risk per LOB where earned premium for each segment for next 12 months not materially different to that of current year:

where

• Ps = Estimate of NEP for each segment (LOB) during the following 12 months.

• FP(existing,s)= The expected PV of NEP for each segment after the following 12 months for existing contracts.

• FP(future,s)= The expected PV of NEP for each segment where the initial recognition date falls in the following 12 months but excluding the premiums to be earned during the 12 months after the valuation date.

114

LOB

1 Motor, third-party liability

2 Motor, other classes

3 Marine, aviation, transport (MAT)

4 Fire and other property damage

5 Third-party liability

6 Credit and suretyship

7 Legal expenses

8 Assistance

9 Miscellaneous

10 Non-prop reinsurance – property

11 Non-prop reinsurance – casualty

12 Non-prop reinsurance – MAT

s)(future,s)(existing,ss)(prem, FPFPPV

s)(future,s)(existing,slast,ss)(prem, FPFPPPV ),max(

Step 1: Volume Measures and Standard Deviation per segment

NLpr = premium & reserve risk (cont)

• The standard derivation for premium risk for each LOB are:

where NPlob is the adjustment factor for non-proportional reinsurance of a line of business allows undertakings to take into account the risk-mitigating effect of particular per risk excess of loss reinsurance.

• Notwithstanding this adjustment, the preparatory document states that the NP adjustment for non-proportional reinsurance of motor liability, fire & 3rd party liability is 80% (i.e. LOB 4, 7 & 8 as per Appendix 3), for non-proportional reinsurance of all other LOBs its 100%.

115

LoB SD for premium risk (gross)

Motor vehicle liability 10%·NPlob

Other motor 8%· NPlob

MAT 15%· NPlob

Fire 8%· NPlob

3rd-party liability 14%· NPlob

Credit 12%· NPlob

Legal expenses 7%· NPlob

Assistance 9%· NPlob

Miscellaneous 13%· NPlob

NP reins (prop) 17%

NP reins (casualty) 17%

NP reins (MAT) 17%

NP

NLpr = premium & reserve risk (cont)

• Volume measure for reserve risk per LOB: where PCOlob = best estimate for net

claims outstanding for each LOBs.

• Standard derivation for (net) reserve risk, as per table:

• Standard deviation for the premium and reserve risk for each LOB are aggregated, using the correlation coefficient of 0.5, as follows:

116

lob

PCOlob)(res,V

)lob,res()lob,prem(

)lob,res()lob,res()lob,res()lob,prem()lob,res()lob,prem()lob,prem()lob,prem(

)lob(

VV

VVVV22

sssss

LOB σ (res,lob)

1 Motor, third-party liability 9%

2 Motor, other classes 8%

3 Marine, aviation, transport (MAT) 11%

4 Fire and other property damage 10%

5 Third-party liability 11%

6 Credit and suretyship 19%

7 Legal expenses 12%

8 Assistance 20%

9 Miscellaneous 20%

10 Non-prop reinsurance – property 20%

11 Non-prop reinsurance – casualty 20%

12 Non-prop reinsurance – MAT 20%

NLpr = premium & reserve risk (cont)

• Overall standard deviation σ is as follows:

where

and

where the index j denotes the geographical segments as set out below and V(prem,j,lob) and V(res,j,lob) denote the volume measures as defined above but restricted to one of the 18 geographical segments j.

For the LOBs, credit& surety and for non-proportional casualty, MAT & property, the geographical diversification DIV set to 1. Firms may set DIVs to 1 if they have no geographical diversification or do not wish to avail of diversification benefits.

117

rxc

crcrcr VVCorrLobV

sss ,2

1

lobreslob

premloblob DIV0.250.75VVV

2

jlob)j,(res,lob)j,(prem,

j

2

lob)j,(res,lob)j,(prem,

lob

VV

VV

DIV

1 Northern Europe 7 South + SE Asia 13 Eastern South America

2 Western Europe 8 Oceania 14 N+S+W South America

3 Eastern Europe 9 Northern Africa 15 NE USA

4 Southern Europe 10 Southern Africa 16 SE USA

5 Central + Western Asia 11 North America (excl USA) 17 NW USA

6 Eastern Asia 12 Caribbean + Central America 18 Western USA

Step 2: Overall Volume Measures and Standard Deviations

NLpr = premium & reserve risk (cont)

• The correlation matrix is

118

CorrLob 1 2 3 4 5 6 7 8 9 10 11 12

1: M (3rd party) 1

2: M (other) 0.5 1

3: MAT 0.5 0.25 1

4: Fire 0.25 0.25 0.25 1

5: 3rd party liab 0.5 0.25 0.25 0.25 1

6: credit 0.25 0.25 0.25 0.25 0.5 1

7: legal exp. 0.5 0.5 0.25 0.25 0.5 0.5 1

8: assistance 0.25 0.5 0.5 0.5 0.25 0.25 0.25 1

9: misc. 0.5 0.5 0.5 0.5 0.5 0.5 0.5 0.5 1

10: reins. (prop) 0.25 0.25 0.25 0.25 0.5 0.5 0.5 0.25 0.25 1

11: reins. (cas) 0.25 0.25 0.5 0.5 0.25 0.25 0.25 0.25 0.5 0.25 1

12: reins. (MAT) 0.25 0.25 0.25 0.5 0.25 0.25 0.25 0.5 0.25 0.25 0.25 1

NLlapse = lapse risk

• When assessing technical provisions, assumptions need to be made on the level of future premiums and the corresponding take-up of options and/or guarantees given in such future premiums. These assumptions need to be stressed and included as a capital charge, as follows:

where:

lapseshock1 = Discontinuance of 40% of the insurance policies for which discontinuance would result in an increase of technical provisions without the risk margin.

lapseshock2 = Decrease of 40% of the number of future insurance or reinsurance contracts used in the calculation of technical provisions associated to reinsurance contracts cover insurance or reinsurance contracts to be written in the future.

• For non-life lapse risk it is assumed that either relevant option exercise rates are not used in the calculation of technical provisions for non-life obligations or, where they are used in the calculation, changes of the relevant option exercise rates used in the calculation of technical provisions would not have a material impact on the value of technical provisions.

119

)lapseshockk(lapseshoc |ΔBOFNL 21,lapse

NLcat = Catastrophe Risk • The underlying assumptions for the natural catastrophe risk sub-module can be summarized as follows:

• The natural catastrophe risk sub-module is based on a consistent, comprehensive, risk commensurate and fair approach to account for all possible natural perils. This had to apply across all countries and perils, as well as for all types of insurers. All member states of the European Economic Area (the European Union, Iceland, Lichtenstein and Norway) plus Switzerland were in scope.

• The calibration of the natural catastrophe risk sub-module is based on “average” conditions for any given country-peril combination. It is assumed that the undertaking’s non- life insurance portfolio is not focused on residential, commercial, industrial or agricultural.

• There is an underlying assumption of an average vulnerability per peril-country combination, as well as an average deductible and an insured to value relationship.

• The scenario based approach for the natural catastrophe risk sub-module assumes that the portfolio of the financial statement date is representative for the whole year. In the design of the geographical diversification coefficient adjusting the volume measure for non-life premium and reserve risk, it is assumed that geographically diversified portfolios are diversified in respect of the type and time of losses which an insurance undertaking faces.

• In the design of the geographical diversification coefficient adjusting the volume measure for natural catastrophe risk (windstorm, earthquake, flood, hail and non-proportional property reinsurance), it is assumed that geographically diversified portfolios are diversified in respect of the type and time of losses which an insurance undertaking faces.

• In the design of the geographical diversification coefficient adjusting the volume measures for natural catastrophe risk (windstorm, earthquake, flood, hail and non-proportional property reinsurance), it is also assumed that the regions represent an appropriate geographical division of the undertakings insurance portfolio in each line of business; i.e. it is assumed that an insurance portfolio of an undertaking with contracts in different regions does not contain sub-portfolios split per region that in fact generate positively correlated losses. This situation can take place when the portfolios are located in few similar (in respect of type and time of losses) countries but assigned to different regions or when portfolios are locally concentrated around both sides of the border between two regions.

120

NLcat = Catastrophe Risk (cont) • Under the non-life underwriting risk module, catastrophe risk is defined in the Directive as: “the risk of loss, or of adverse

change in the value of insurance liabilities, resulting from significant uncertainty of pricing and provisioning assumptions related to extreme or exceptional events.”

• The CAT risk sub-module shall consist of the following sub-modules: (a) the natural catastrophe risk sub-module. (b) the sub-module for catastrophe risk of non-proportional property reinsurance. (c) the man-made catastrophe risk sub-module. (d) the sub-module for other non-life catastrophe risk. where SCRnatCAT = Capital requirement for natural catastrophe risk. SCRnpproperty = Capital requirement for the catastrophe risk of non-proportional property reinsurance. SCRmmCAT = Capital requirement for man-made catastrophe risk. SCRCATother = Capital requirement for other non-life catastrophe risk. • The graph below shows examples of the diversification from the formula above show benefits of between 10% and 40%

depending upon quantum of the different sub-modules.

121

2CATother

2mmCAT

2nppropertynatCATNL_CAT )(SCR)(SCR)SCR (SCRSCR

NLcat = Catastrophe Risk (cont)

122

NLCAT

Other

Man Made

XoL Property Re

NatCAT

Subsidence

Windstorm

Earthquake

Flood

Hail

Credit & Surety

Motor

Marine

Aviation

Fire

Liability

NL_CATNatCat = Natural Catastrophe

• The natural catastrophe risk sub-module shall consist of the following sub-modules:

(i) the windstorm risk sub-module.

(ii) the earthquake risk sub-module.

(iii) the flood risk sub-module.

(iv) the hail risk sub-module.

(v) the subsidence risk sub-module.

The capita requirement for natural catastrophe risk shall be equal to:

where the sum includes all possible combinations of the sub-modules above.

• The graph below shows examples of the diversification from the formula above show benefits of between 30% and 55% depending upon quantum of the different sub-modules.

123

2

i

inatCAT SCR(SCR

NL_CATNatCat Windstorm

where:

(a) the sum includes all possible combinations (r,s) of the regions.

(b) CorrWSr,s denotes the correlation coefficient for windstorm risk for region r and region s.

(c) SCR(windstorm,r) and SCR(windstorm,s) denote the capital requirements for windstorm risk in region r and s respectively.

(d) SCR(windstorm,other) denotes the capital requirement for windstorm risk in regions other than those set out below.

124

2)( other) ,(Windstorm

sr,s) ,(Windstormr),(Windstormsr,Windstorm SCRSCRSCRCorrWSSCR

Regions where NatCAT not calculated from premium

Member States of European Union

Andorra

Croatia

Iceland

Lichtenstein

Monaco

Norway

San Marino

Swiss Confederation

Vatican City State

NL_CATNatcat Windstorm (cont)

• Based upon two events where no new insurance risk mitigation technique is acquired between the events:

• Where current reinsurance contracts allow for reinstatements, insurance and reinsurance undertakings shall take into account future management actions in relation to the reinstatements between the first and the second event. The assumptions about future management actions should be realistic, objective and verifiable.

• Specified regions and windstorm risk factors:

125

)SCR ,max(SCRSCR r_B) ,(windstormr_A) ,(windstormr),(windstorm

X% of specified loss in region r 100% * L(windstorm,r)

followed by Y% of specified loss in region r

20% * L(windstorm,r)

X% of specified loss in region r 80% * L(windstorm,r)

followed by Y% of specified loss in region r

40% * L(windstorm,r)

Regions Q (windstorm,r) Regions Q (windstorm,r)

Austria AT 0.08% Netherlands NL 0.18%

Belgium BE 0.16% Norway NO 0.08%

Czech CZ 0.03% Poland PL 0.04%

Switzerland CH 0.08% Spain ES 0.03%

Denmark DK 0.25% Sweden SE 0.09%

France FR 0.12% Britain UK 0.17%

Germany DE 0.09% Guadeloupe GU 2.74%

Iceland IS 0.03% Martinigue MA 3.19%

Ireland IE 0.20% Saint Martin SM 5.16%

Luxemburg LU 0.10% Reunion RE 2.50%

NL_CATNatCat Windstorm (cont)

where:

(a) Q(windstorm,r) denotes the windstorm risk factor for specified region r

(b) The sum includes all possible combinations of windstorm zones (i,j);

(c) Corr(windstorm_r,i,j) denotes the correlation coefficient for windstorm risk in windstorm zones i and j of specified region r

(d) WSI(windstorm_r,i) and WSI(windstorm_r,j) denote the weighted sums insured for windstorm risk in windstorm zones i and j of specified region r.

• Windstorm zones and sum insured:

where W(windstorm,r,i) denotes the risk weight for windstorm risk in windstorm zone i of region r and SI(windstorm,r,i) denotes the sum insured for windstorm risk in windstorm zone i of region r.

– the windstorm zones of a specified region shall be made up of geographical divisions of that region which are sufficiently homogeneous in relation to the windstorm risk. Together the zones shall comprise the whole region. The zones shall be mutually exclusive of one another.

126

ji,

j) _r,(Windstormi)_r,(Windstormji, r,windstorm_rWindstorm_rWindstorm_ WSIWSICorrQL

i) _r,(windstormi) _r,(windstormi)_r,(windstorm SIWWSI

i) ,property_r (onshorei) r,(property_i)_r,(windstorm SISISI

NL_CATNatCat Windstorm (cont) • Windstorm zones and sum insured (cont):

– The risk weight for windstorm risk W(windstorm,r,i) in a particular windstorm zone i of a particular region r shall be specified in such a way that the product of W(windstorm,r,i) and the windstorm risk factor Q(windstorm,r) for region r corresponds to the annual loss caused by windstorm in zone i of region r, expressed as a portion of the sum insured and calibrated using a VAR measure with a 99.5 % confidence level.

– For all combinations (i,j) of two windstorm zones of one of those regions, the correlation coefficient Corr(windstorm_r,i,j) for windstorm risk in particular windstorm zones i and j of a particular region r shall be selected from one of the following figures: 0, 0.25, 0.5, 0.75 or 1. The correlation coefficient shall be selected in such a way that:

(a) the correlation coefficient reflects the dependency between windstorm risk in zone i and j, taking into account any non-linearity of the dependence;

(b) it results in a specified windstorm loss L(windstorm,r) that corresponds to the annual loss caused by windstorm in region r expressed as a portion of the sum insured and calibrated using a VAR measure with a 99.5 % confidence level.

• Correlation matrix between regions for windstorm:

127

  AT BE CH CZ DE DK ES FR UK IE IS LU NL NO PL SE GU MA SM

AT 1.00 0.25 0.50 0.25 0.25 - - 0.25 - - - 0.25 0.25 - - - - - -

BE 0.25 1.00 0.25 0.25 0.50 0.25 - 0.50 0.50 0.25 - 0.75 0.75 - 0.25 - - - -

CH 0.50 0.25 1.00 0.25 0.25 - 0.25 0.50 - - - 0.25 0.25 - - - - - -

CZ 0.25 0.25 0.25 1.00 0.25 - - 0.25 - - - 0.25 0.25 - 0.25 - - - -

DE 0.25 0.50 0.25 0.25 1.00 0.50 - 0.50 0.25 0.25 - 0.50 0.50 0.25 0.50 - - - -

DK - 0.25 - - 0.50 1.00 - 0.25 0.25 - - 0.25 0.50 0.50 0.25 0.50 - - -

ES - - 0.25 - - - 1.00 0.25 - - - - - - - - - - -

FR 0.25 0.50 0.50 0.25 0.50 0.25 0.25 1.00 0.25 - - 0.50 0.50 - - - - - -

UK - 0.50 - - 0.25 0.25 - 0.25 1.00 0.50 - 0.25 0.50 0.25 - - - - -

IE - 0.25 - - 0.25 - - - 0.50 1.00 - 0.25 0.25 - - - - - -

IS - - - - - - - - - - 1.00 - - - - - - - -

LU 0.25 0.75 0.25 0.25 0.50 0.25 - 0.75 0.25 0.25 - 1.00 0.50 0.25 0.25 - - - -

NL 0.25 0.75 0.25 0.25 0.50 0.50 - 0.50 0.50 0.25 - 0.50 1.00 0.25 0.25 - - - -

NO - - - - 0.25 0.50 - - 0.25 - - 0.25 0.25 1.00 - 0.50 - - -

PL - 0.25 - 0.25 0.50 0.25 - - - - - 0.25 0.25 - 1.00 - - - -

SE - - - - - 0.50 - - - - - - - 0.50 - 1.00 - - -

GU - - - - - - - - - - - - - - - - 1.00 1.00 1.00

MA - - - - - - - - - - - - - - - - 1.00 1.00 1.00

SM - - - - - - - - - - - - - - - - 1.00 1.00 1.00

RE - - - - - - - - - - - - - - - - - - -

NL_CATNatCat Windstorm (cont)

• Losses in regions not specified.

– From obligations of property insurance (LOB 7 and/or proportional reinsurance thereof as set out in Appendix 3) in relation to property that cover windstorm risk and other obligations such as marine, aviation or transport insurance (LOB 6 and/or proportional reinsurance thereof as set out in Appendix 3) in relation to onshore property.

where DIV is calculated as per NLpremium&reserve and restricted to regions 5 to 18 in that calculation. The splitting of the premium for calculation of DIVwindstorm for policies with exposures in multiple geographical zones should be based on exposure split.

• The losses assumed for unspecified regions, such as the US, have been the cause of much comment from industry. European insurers writing natCat exposed business outside of the EU believe that the stresses are oversimplified and too conservative. The graph below shows the different factors (ranging from 88% to 175%) that the formula above would apply to premium for different levels of DIV.

128

windstormwindstormother) (windstorm PDIVL )5.05.0(75.1

NL_CATNatCat Earthquake

where:

(a) the sum includes all possible combinations (r,s) of the regions specified below.

(b) CorrEQr,s denotes the correlation coefficient for earthquake risk for region r and region s.

(c) SCR(earthquake,r) and SCR(earthquake,s) denote the capital requirements for earthquake risk in region r and s respectively.

(d) SCR(earthquake,other) denotes the capital requirement for earthquake risk in regions other than those specified below.

129

2)( other) e,(Earthquak

sr,s) e,(Earthquakr)e,(Earthquaksr,Earthquake SCRSCRSCRCorrEQSCR

Regions Q (earthquake,r) Regions Q (earthquake,r)

Austria AT 0.10% Hungary HU 0.20%

Belgium BE 0.02% Italy IT 0.80%

Bulgaria BG 1.60% Malta MT 1.00%

Croatia CR 1.60% Portugal PT 1.20%

Cyprus CY 2.12% Romania RO 1.70%

Czech CZ 0.10% Slovak SK 0.15%

Switzerland CH 0.25% Slovenia SI 1.00%

France FR 0.06% Guadeloupe GU 4.09%

Germany DE 0.10% Martinigue MA 4.71%

Hellenic HE 1.85% Saint Martin SM 5.00%

NL_CATNatCat Earthquake (cont)

where:

(a) Q(earthquake,r) denotes the earthquake risk factor for specified region r

(b) The sum includes all possible combinations of earthquake zones (i,j);

(c) Corr(earthquake_r,i,j) denotes the correlation coefficient for earthquake risk in earthquake zones i and j of region r

(d) WSI(earthquake_r,i) and WSI(earthquake_r,j) denote the weighted sums insured for earthquake risk in earthquake zones i and j of region r.

• Earthquake zones and sum insured:

where W(earthquake,r,i) denotes the risk weight for earthquake risk in earthquake zone i of region r and SI(earthquake,r,i) denotes the sum insured for earthquake risk in earthquake zone i of region r.

– the earthquake zones of a particular region shall be made up of geographical divisions of that region which are sufficiently homogeneous in relation to the earthquake risk. Together the zones shall comprise the whole region. The zones shall be mutually exclusive of one another.

130

ji,

j) e_r,(Earthquaki)e_r,(Earthquakji, _r,earthquake_rEarthquake_rEarthquake WSIWSICorrQL

i) e_r,(earthquaki) e_r,(earthquaki)e_r,(earthquak SIWWSI

i) ,property_r (onshorei) r,(property_i)e_r,(earthquak SISISI

NL_CATNatCat Earthquake (cont)

• Earthquake zones and sum insured (cont):

– The risk weight for earthquake risk W(earthquake,r,i) in a particular earthquake zone i of a particular region r shall be specified in such a way that the product of W(earthquake,r,i) and the earthquake risk factor Q(earthquake,r) for region r corresponds to the annual loss caused by earthquake in zone i of region r, expressed as a portion of the sum insured and calibrated using a VAR measure with a 99.5 % confidence level.

– For all combinations (i,j) of two earthquake zones of one of those regions, the correlation coefficient Corr(earthquake_r,i,j) for earthquake risk in particular earthquake zones i and j of a particular region r shall be selected from one of the following figures: 0, 0.25, 0.5, 0.75 or 1. The correlation coefficient shall be selected in such a way that:

(a) the correlation coefficient reflects the dependency between earthquake risk in zone i and j, taking into account any non-linearity of the dependence;

(b) it results in a specified earthquake loss L(earthquake,r) that corresponds to the annual loss caused by earthquake in region r expressed as a portion of the sum insured and calibrated using a VAR measure with a 99.5 % confidence level.

• Correlation matrix between specified regions for earthquake:

131

AT BE BG CR CY FR DE HE HU IT MT PT RO SI CZ CH SK GU MA STAT 1.00 - - - - - - - - - - - - - - - 0.25 - - - BE - 1.00 - - - - 0.25 - - - - - - - - - - - - - BG - - 1.00 - - - - 0.25 - - - - - - - - - - - - CR - - - 1.00 - - - - - - - - - 0.25 - - - - - - CY - - - - 1.00 - - - - - - - - - - - - - - - FR - - - - - 1.00 - - - - - - - - - 0.25 - - - - DE - 0.25 - - - - 1.00 - - - - - - - - 0.25 - - - - HE - - 0.25 - - - - 1.00 - - - - - - - - - - - - HU - - - - - - - - 1.00 - - - - - - - - - - - IT - - - - - - - - - 1.00 - - - 0.25 - - - - - - MT 1.00 - - - - - - - - - PT - - - - - - - - - - 1.00 - - - - - - - - RO - - - - - - - - - - - 1.00 - - - - - - - SI - - - 0.25 - - - - - 0.25 - - 1.00 - - - - - - CZ - - - - - - - - - - - - - 1.00 - - - - - CH - - - - - 0.25 0.25 - - - - - - - 1.00 - - - - SK 0.25 - - - - - - - - - - - - - - 1.00 - - - GU - - - - - - - - - - - - - - - - 1.00 0.75 0.75 MA - - - - - - - - - - - - - - - - 0.75 1.00 0.75 ST - - - - - - - - - - - - - - - - 0.75 0.75 1.00

NL_CATNatCat Earthquake (cont)

• Losses in regions not specified.

– From obligations of property insurance (LOB 7 and/or proportional reinsurance thereof as set out in Appendix 3) in relation to property that cover earthquake risk and other obligations such as marine, aviation or transport insurance (LOB 6 and/or proportional reinsurance thereof as set out in Appendix 3) in relation to onshore property.

where DIV is calculated as per NLpremium&reserve and restricted to regions 5 to 18 in that calculation.

• The losses assumed for unspecified regions, such as the US, have been the cause of much comment from industry. European insurers writing natCat exposed business outside of the EU believe that the stresses are oversimplified and too conservative. The graph below shows the different factors (ranging from 60% to 120%) that the formula above would apply to premium for different levels of DIV.

132

earthquakeearthquakeother) e(earthquak PDIVL )5.05.0(2.1

NL_CATNatCat Flood

where:

(a) the sum includes all possible combinations (r,s) of the specified regions.

(b) CorrFLr,s denotes the correlation coefficient for flood risk for region r and region s.

(c) SCR(flood,r) and SCR(flood,s) denote the capital requirements for flood risk in region r and s respectively.

(d) SCR(flood,other) denotes the capital requirement for flood risk in regions other than those specified below.

133

2)( other) (Flood,

sr,s) (Flood,r)(Flood,sr,Flood SCRSCRSCRCorrFLSCR

Regions Q (flood,r) Regions Q (flood,r)

Austria AT 0.13% Hungary HU 0.40%

Belgium BE 0.10% Italy IT 0.10%

Bulgaria BG 0.15% Poland PL 0.16%

Czech CZ 0.30% Romania RO 0.40%

Switzerland CH 0.15% Slovak SK 0.45%

France FR 0.10% Slovenia SI 0.30%

Germany DE 0.20% Britain UK 0.10%

NL_CATNatCat Flood (cont)

• Based upon two events where no new insurance risk mitigation technique is acquired between the events:

• Specified flood loss in a particular region r shall be equal to:

where:

(a) Q(flood,r) denotes the flood risk factor for specified region r

(b) The sum includes all possible combinations of flood zones (i,j);

(c) Corr(flood_r,i,j) denotes the correlation coefficient for flood risk in flood zones i and j of region r

(d) WSI(flood_r,i) and WSI(flood_r,j) denote the weighted sums insured for flood risk in flood zones i and j of region r.

• Flood zones and sum insured:

where W(flood,r,i) denotes the risk weight for flood risk in flood zone i of region r and SI(flood,r,i) denotes the sum insured for flood risk in flood zone i of specified region r.

134

)SCR ,max(SCRSCR r_B) (flood,r_A) (flood,r)(flood,

X% of Specified loss in region r 65% * L(flood,r)

followed by Y% of Specified loss in region r

45% * L(flood,r)

X% of specified loss in region r 100% * L(flood,r)

followed by Y% of specified loss in region r

10% * L(flood,r)

ji,j) (flood_r,i)(flood_r,ji, flood_r,Flood_rFlood_r WSIWSICorrQL

i) (flood_r,i) (flood_r,i)(flood_r, SIWWSI

i) (motor_r,i) ,property_r (onshorei) r,(property_i)(flood_r, SISISISI 5.1

NL_CATNatCat Flood (cont)

• Flood zones and sum insured (cont):

– the flood zones of a particular region shall be made up of geographical divisions of that region which are sufficiently homogeneous in relation to the flood risk. Together the zones shall comprise the whole region. The zones shall be mutually exclusive of one another.

– The risk weight for flood risk W(flood,r,i) in a particular flood zone i of a particular region r shall be specified in such a way that the product of W(flood,r,i) and the flood risk factor Q(flood,r) for region r corresponds to the annual loss caused by flood in zone i of region r, expressed as a portion of the sum insured and calibrated using a VAR measure with a 99.5 % confidence level.

– For all combinations (i,j) of two flood zones of one of those regions, the correlation coefficient Corr(flood_r,i,j) for flood risk in particular flood zones i and j of a particular region r shall be selected from one of the following figures: 0, 0.25, 0.5, 0.75 or 1. The correlation coefficient shall be selected in such a way that:

(a) the correlation coefficient reflects the dependency between flood risk in zone i and j, taking into account any non-linearity of the dependence;

(b) it results in a specified flood loss L(flood,r) that corresponds to the annual loss caused by flood in region r expressed as a portion of the sum insured and calibrated using a VAR measure with a 99.5 % confidence level.

• Correlation coefficient Corr(flood_r,i,j) for flood risk:

135

AT BE CH CZ FR DE HU IT BG PL RO SI SK UK

AT 1.00 - 0.25 - - 0.75 0.50 - 0.25 0.25 0.25 - 0.50 -

BE - 1.00 - - 0.25 0.25 - - - - - - - -

CH 0.25 - 1.00 - 0.25 0.25 - 0.25 - - - - - -

CZ 0.50 - - 1.00 - 0.50 0.25 - - 0.75 0.25 - 0.75 -

FR - 0.25 0.25 - 1.00 0.25 - - - - - - - -

DE 0.75 0.25 0.25 0.50 0.25 1.00 0.25 - - 0.75 0.25 - 0.25 -

HU 0.50 - - 0.25 - 0.25 1.00 - 0.25 0.25 0.50 - 0.25 -

IT - - 0.25 - - - - 1.00 - - - 0.25 - -

BG 0.25 - - - - - 0.25 - 1.00 - 0.50 - - -

PL 0.25 - - 0.75 - 0.75 0.25 - - 1.00 0.25 - 0.25 -

RO 0.25 - - 0.25 - 0.25 0.50 - 0.50 0.25 1.00 - 0.25 -

SI - - - - - - - 0.25 - - - 1.00 0.25 -

SK 0.50 - - 0.75 - 0.25 0.25 - - 0.25 0.25 0.25 1.00 -

UK - - - - - - - - - - - - - 1.00

NL_CATNatcat = flood (cont)

• Losses in regions not specified.

– From obligations of property insurance (LOB 7 and/or proportional reinsurance thereof as set out in Appendix 3) in relation to property that cover flood risk and other obligations such as marine, aviation or transport insurance (LOB 6 and/or proportional reinsurance thereof as set out in Appendix 3) in relation to onshore property and in relation to property damage from motor insurance (LOB 5 and/or proportional reinsurance thereof as set out in Appendix 3).

where DIV is calculated as per NLpremium&reserve and restricted to regions 5 to 18 in that calculation.

• The graph below shows the different factors (ranging from 55% to 110%) that the formula above would apply to premium for different levels of DIV.

136

floodfloodother) (flood PDIVL )5.05.0(1.1

NL_CATNatcat = hail

where:

(a) the sum includes all possible combinations (r,s) of the specified regions below.

(b) CorrHLr,s denotes the correlation coefficient for hail risk for region r and region s.

(c) SCR(hail,r) and SCR(hail,s) denote the capital requirements for hail risk in region r and s respectively.

(d) SCR(hail,other) denotes the capital requirement for hail risk in regions other than those set out below.

137

2)( other) (Hail,

sr,s) (Hail,r)(Hail,sr,Hail SCRSCRSCRCorrHLSCR

Regions Q (hail,r) Regions Q (hail,r)

Austria AT 0.08% Italy IT 0.05%

Belgium BE 0.03% Luxemburg LU 0.03%

Switzerland CH 0.06% Netherlands NL 0.02%

France FR 0.01% Spain ES 0.01%

Germany DE 0.02%

NL_CATNatcat = hail (cont)

• Specified flood loss in a particular region r shall be equal to:

where:

(a) Q(hail,r) denotes the hail risk factor for specified region r

(b) The sum includes all possible combinations of hail zones (i,j)

(c) Corr(hail_r,i,j) denotes the correlation coefficient for hail risk in hail zones i and j of region r

(d) WSI(hail_r,i) and WSI(hail_r,j) denote the weighted sums insured for hail risk in hail zones i and j of region r.

• Hail zones and sum insured:

where W(hail,r,i) denotes the risk weight for hail risk in hail zone i of region r and SI(hail,r,i) denotes the sum insured for hail risk in hail zone i of region r.

138

)SCR ,max(SCRSCR r_B) (hail,r_A) (hail,r)(hail,

X% of Specified loss in region r 70% * L(hail,r)

followed by Y% of Specified loss in region r

50% * L(hail,r)

X% of specified loss in region r 100% * L(hail,r)

followed by Y% of specified loss in region r

20% * L(hail,r)

ji,

j) (hail_r,i)(hail_r,ji, hail_r,Hail_rHail_r WSIWSICorrQL

i) (hail_r,i) (hail_r,i)(hail_r, SIWWSI

i) (motor_r,i) ,property_r (onshorei) r,(property_i)(hail_r, SISISISI 5

NL_CATNatcat = hail (cont)

• Hail zones and sum insured (cont):

– the hail zones of a particular region shall be made up of geographical divisions of that region which are sufficiently homogeneous in relation to the hail risk. Together the zones shall comprise the whole region. The zones shall be mutually exclusive of one another.

– The risk weight for hail risk W(hail,r,i) in a particular hail zone i of a particular region r shall be specified in such a way that the product of W(hail,r,i) and the hail risk factor Q(hail,r) for region r corresponds to the annual loss caused by hail in zone i of region r, expressed as a portion of the sum insured and calibrated using a VAR measure with a 99.5 % confidence level.

– For all combinations (i,j) of two hail zones of one of those regions, the correlation coefficient Corr(hail_r,i,j) for hail risk in particular hail zones i and j of a particular region r shall be selected from one of the following figures: 0, 0.25, 0.5, 0.75 or 1. The correlation coefficient shall be selected in such a way that:

(a) the correlation coefficient reflects the dependency between hail risk in zone i and j, taking into account any non-linearity of the dependence;

(b) it results in a specified hail loss L(hail,r) that corresponds to the annual loss caused by hail in region r expressed as a portion of the sum insured and calibrated using a VAR measure with a 99.5 % confidence level.

• Correlation coefficient Corr(hail_r,i,j) for hail risk in specified regions:

139

AT BE FR DE IT LU NL CH ES

AT 1.00 - - - - - - - -

BE - 1.00 - - - 0.25 0.25 - -

FR - 0.25 1.00 - - - - - -

DE - - - 1.00 - - - - -

IT - - - - 1.00 - - - -

LU - 0.25 - - - 1.00 0.25 - -

NL - 0.25 - - - 0.25 1.00 - -

CH - - - - - - - 1.00 -

ES - - - - - - - - 1.00

NL_CATNatcat = hail (cont)

• Losses in regions not specified.

– From obligations of property insurance (LOB 7 and/or proportional reinsurance thereof as set out in Appendix 3) in relation to property that cover hail risk and other obligations such as marine, aviation or transport insurance (LOB 6 and/or proportional reinsurance thereof as set out in Appendix 3) in relation to onshore property and in relation to property damage from motor insurance (LOB 5 and/or proportional reinsurance thereof as set out in Appendix 3).

• The graph below shows the different factors (ranging from 15% to 30%) that the formula above would apply to premium for different levels of DIV.

140

hailhailother) (hail PDIVL )5.05.0(3.0

NL_CATNatcat = subsidence

where:

(a) The sum includes all possible combinations of subsidence zones (i,j);

(b) Corr(subsidence i,j) denotes the correlation coefficient for subsidence risk in subsidence zones i and j

(c) WSI(subsidence i) and WSI(subsidence j) denote the weighted sums insured for subsidence risk in subsidence zones i and j.

• Subsidence zones and sum insured:

where W(subsidence,i) denotes the risk weight for subsidence risk in subsidence zone i and SI(subsidence,i) denotes the sum insured for subsidence risk in subsidence zone i from line of business 7 (and/or proportional reinsurance thereof) as set out in Appendix 3 in relation to property.

– The subsidence zones above shall be made up of geographical divisions of the territory of the French Republic which are sufficiently homogeneous in relation to the subsidence risk that the insurance and reinsurance undertakings are exposed to in relation to the territory. Together the zones shall comprise the whole territory. The zones shall be mutually exclusive of one another.

– For all combinations (i,j) of two subsidence zones of one of those regions, the correlation coefficient Corr(subsidence i,j) for subsidence risk in particular subsidence zones i and j shall be selected from one of the following figures: 0, 0.25, 0.5, 0.75 or 1. The correlation coefficient shall be selected in such a way that:

a) the correlation coefficient reflects the dependency between subsidence risk in zone i and j, taking into account any non-linearity of the dependence;

b) it results in a specified subsidence loss L(subsidence) that corresponds to the annual loss caused by subsidence from line of business 7 (and/or proportional reinsurance thereof) as set out in Appendix 3 in relation to property as expressed as a portion of the sum insured of same and calibrated using a VAR measure with a 99.5 % confidence level.

141

ji,

j) e,(subsidenci)e,(subsidencji, subsidenceSubsidence WSIWSICorrL 0005.0

i) e(subsidenci) e(subsidenci) e(subsidenc SIWWSI

NL_CATNPP = Non-Proportional Re

where

• Pnnproperty is the estimate of the premiums to be earned by the insurance or reinsurance undertaking for each contract that covers the reinsurance obligations of line of business 16 other than non-proportional reinsurance obligations relating to insurance obligations included in lines of business 7 as set out in Appendix 3 ; for this purpose premiums shall be gross, without deduction of premiums for reinsurance contracts.

• DIVnpproperty is calculated as per premium & reserve risk calculation of diversification based on the premiums earned by the (re)insurer in line of business 16 as set out in Appendix 3.

• The graph below shows the different factors (ranging from 125% to 250%) that the formula above would apply to premium for different levels of DIV.

142

nnpropertynnpropertynnproperty PDIVL )5.05.0(5.2

)(L |ΔBOFSCR nppropertyNPproperty

NL_CATMMcat = Manmade CAT

The underlying assumptions for the man-made catastrophe risk sub-module can be summarized as follows:

• The calibration factors for man-made catastrophe risk are likely to be understated, compared to the risk for an individual undertaking. Countering this, the market represented by the data is likely to have a mix of business that is likely to be higher risk (larger sized risks and risks that are inherently more exposed to risk of loss) than the typical EU undertaking. Hence the factors calculated could overstate the 1 in 200 loss for undertakings writing only small limits and/or risks with low inherent exposure to liability losses. It is assumed that the overestimation/underestimation of the factors cancel each other out.

• For motor third party liability the fundamental assumption used is that the number of vehicles insured is the best measure of exposure. The resulting loss is extrapolated down to a 1-in-200 year level using a Pareto assumption and allowance is made for policy limits common in some countries. The main implicit assumption is that the number of vehicles insured is a good measure of frequency of extreme loss – i.e. all vehicles are equally likely to cause a major loss, or all undertakings have a similar mix of vehicle types.

• While for fire risk (fire, explosion and acts of terror) explosion or acts of terrorism can trigger general liability insurance coverage losses, the general liability line of business is assumed not to be considered in the fire sub-module.

• It is assumed that for third party liability insurance the risk of an accumulation of a large number of similar claims is not material.

143

NL_CATMMcat = Manmade CAT (cont)

• The man-made catastrophe risk sub-module shall consist of the following sub-modules:

(1) the motor vehicle liability sub-module

. (2) the marine risk sub-module.

(3) the aviation risk sub-module.

(4) the fire risk sub-module.

(5) the liability risk sub-module.

(6) the credit & surety risk sub-module.

The capital requirement for man-made catastrophe risk shall be equal to: where the sum includes all possible combinations of the sub-modules above.

• As a square root of the sum of the squares calculation, the diversification benefits are similar to those for the natCAT sub-module of between 30% and 60% , as per the graph below:

144

2

i

imade-man SCR(SCR

NL_CATMotor= motor liability

where

• Na = Number of vehicles insured in lines of business 4 (or proportional reinsurance of LOB 4) as set out in Appendix 3 with a deemed policy limit (gross) above €24 million.

• Nb = Number of vehicles insured in lines of business 4 (or proportional reinsurance of LOB 4) as set out in Appendix 3 with a deemed policy limit (gross) at or below €24 million.

• The number of motor vehicles covered by the proportional reinsurance obligations of the (re)insurer shall be weighted by the relative share of the undertaking's obligations in respect of the sum insured of the motor vehicles.

• The deemed policy limit shall be the overall limit of the motor vehicle liability insurance policy or, where no such overall limit is specified in the terms and conditions of the policy, the sum of the limits for damage to property and for personal injury. Where the policy limit is specified as a maximum per victim, the deemed policy limit shall be based on the assumption of ten victims.

145

)20000;min(95.005.0,120max(50000 bbamotorCAT NNNL

)(L |ΔBOFSCR motorCATmotorCAT

NL_CATMarine= marine

• where SCRtanker is the capital requirement for the (gross) risk of a tanker collision and SCRplatform is the capital requirement for the (gross) risk of a platform explosion.

• For the tanker collision loss, the maximum relates to all oil and gas tankers insured by the (re)insurer in respect of tanker collision covered by marine, aviation or transport insurance or proportional reinsurance thereof (LOB 6 & 18 in Appendix 3) or non-proportional reinsurance of such exposures.

• SI(hull,t) = Sum insured for marine hull insurance and reinsurance in relation to tanker t.

• SI(liab,t) = Sum insured for marine liability insurance and reinsurance in relation to tanker t.

• SI(pollution,t) = Sum insured for marine pollution insurance and reinsurance in relation to tanker t.

• For the platform explosion loss, the maximum relates to all oil and gas platforms insured by the (re)insurer in respect of tanker collision covered by marine, aviation or transport insurance or proportional reinsurance thereof (LOB 6 & 18 in Appendix 3) or non-proportional reinsurance of such exposures.

• SIp = Accumulated sum insured in relation to platform p for obligations to compensate for property damage, the expenses for the removal of wreckage, loss of production income, the expenses for capping of the well or making the well secure, and liability insurance and reinsurance obligations.

146

)SISISIL t),(pollutiont)(liab,t)(hull,tanker (maxt

)(L |ΔBOFSCR tankertanker

2Platform

2Tanker )(SCR)(SCRSCR Marine

)(L |ΔBOFSCR platformplatform

)SIL pplatform (maxt

NL_CATAviation= aviation

where the maximum relates to all aircraft insured by the (re)insurer in respect of aviation hull and liability covered by marine, aviation or transport insurance or proportional reinsurance thereof (LOB 6 & 18 in Appendix 3) or non-proportional reinsurance of such exposures

• SIa = Sum insured (gross) for aviation hull insurance and reinsurance and aviation liability insurance and reinsurance in relation to aircraft a

147

)(L |ΔBOFSCR aviationaviation

)SIL aaviation (maxa

NL_CATFire= fire

where

• SIa = Largest fire risk concentration of the undertaking from multiple contracts through a set of buildings with the largest sum insured meets the following conditions:

» the undertaking has insurance or reinsurance obligations for LOB 7 (and proportional reinsurance thereof) as per Appendix 3 in relation to each building which cover damage due to fire or explosion, including as a result of terrorist attacks.

» all buildings are partly or fully located within a radius of 200 meters.

The set of buildings may be covered by one or several insurance or reinsurance contracts.

148

)(L |ΔBOFSCR firefire

)SIL afire (maxa

NL_CATliability = liability

where:

(a) The sum includes all possible combinations of liability risk groups (i,j);

(b) Corr(liability i,j) denotes the correlation coefficient for liability risk of liability risk groups i and j

(c) SCR(liability i) and SCR(liability j) denote the capital requirement for liability risk of liability risk group i and j respectively.

• Liability risk groups are defined as follows:

1) Professional malpractice liability insurance obligations; liability insurance obligations included in general liability (LOB 8 in Appendix 3) which cover liabilities arising out of professional practice in relation to clients and patients.

2) Employers liability insurance obligations: liability insurance obligations included in general liability (LOB 8 in Appendix 3) which cover liabilities of employers arising out of death, illness, accident, disability or infirmity of an employee in the course of the employment.

3) Directors and officers insurance obligations: liability insurance obligations included in general liability (LOB 8 in Appendix 3) which cover liabilities of directors and officers of a company, arising out of the management of that company, or losses of the company itself to the extent it indemnifies its directors and officers in relation to such liabilities.

4) Personal liability insurance obligations: liability insurance obligations included in general liability (LOB 8 in Appendix 3) which cover liabilities of natural persons in their capacity of private householders.

5) Non-proportional reinsurance obligations: excess liability insurance obligations relating to general liability (LOB 8 in Appendix 3) coverage above.

149

ji,

j),(liabilityi),(liabilityji,liability liability SCRSCRCorrSCR

NL_CATliability= liability (cont)

where

• P(liability,i) = Gross premiums earned during the last 12 months in relation to insurance and reinsurance obligations in liability risk group i

• Lim(i,1) = Largest liability limit of indemnity provided in liability risk group i

The calculation of the loss in basic own funds shall be based on the following assumptions:

(a) the loss of liability risk group i is caused by ni claims, where ni is equal to the lowest integer that exceeds the following amount:

(b) where undertaking provides unlimited cover in liability risk group i, the number of claims ni is equal to 1;

(c) the losses caused by the ni claims are representative for the business of the insurance or reinsurance undertaking in liability risk group i and sum up to the loss of liability risk group i.

150

)(L |ΔBOFSCRliabilityliability

i),(liabilityi),(liabilityi),(liability PL f

f(liability,i) Liability Correlations

Group 1 2 3 4 5

100% 1 1.00 - 0.50 0.25 0.50

160% 2 - 1.00 - 0.25 0.50

160% 3 0.50 - 1.00 0.25 0.50

100% 4 0.25 0.25 0.25 1.00 0.50

210% 5 0.50 0.50 0.50 0.50 1.00

)1,(15.1 iLim

f

i)y,P(liabiliti),(liability

NL_CATCredit&Surety= credit & surety

• Where SCRdefault is the loss in basic own funds that would result from an instantaneous default of the two largest exposures relating to obligations included in credit and suretyship insurance and proportional reinsurance thereof (LOB 9 and 21 in Appendix 3). The determination of the two largest exposures shall be based on a comparison of the net loss-given-default (LGD) of the credit insurance exposures.

• Ldefault = Assume the loss-given-default (gross) of each credit insurance exposure is 10 % of the sum insured in relation to the two largest credit insurance exposures.

• Where SCRrecession is the capital requirement for recession risk:

• Lrecession = Instantaneous loss of an amount (gross) that is equal to 100 % of the gross premiums earned during the last 12 months for line of business 9 (and proportional reinsurance thereof) as per Appendix 3.

151

)(L |ΔBOFSCR defaultdefault

2Recession

2Default )(SCR)(SCRSCR Credit

)(L |ΔBOFSCR recessionrecession

NL_CATOther= Other Non-Life CAT

where

• Pi = Estimate of the gross premium following 12 months in relation to the groups of insurance and reinsurance obligations.

and:

152

)(L |ΔBOFSCR otherother

2222 )P(c)P(c)P(c)PcP(cL 5544332211 other

LOB ci

1 LOB 6 (and proportional reinsurance thereof) in Appendix 3

other than marine & aviation insurance and reinsurance.

100%

2 XoL reinsurance LOB 15 in Appendix 3 other than marine &

aviation reinsurance.

250%

3 LOB 12 (and proportional reinsurance thereof) in Appendix 3

other than extended warranty insurance and reinsurance

obligations provided that the portfolio of these obligations is

highly diversified and these obligation do not cover the costs of

product recalls.

40%

4 XoL reinsurance LOB 14 in Appendix 3 other than general

liability reinsurance.

250%

5 Non-proportional reinsurance of LOB 9. 250%

Health Underwriting Risk Module

Risk arising from the underwriting of health insurance obligations, whether it is pursued on a similar technical basis to that of life insurance or not, following from both the perils covered and the processes used in the conduct of business, covering the following: (a) the risk of loss, or of adverse change in the value of insurance liabilities, resulting from changes in the level, trend, or volatility

of the expenses incurred in servicing insurance or reinsurance contracts (SLT Health). (b) the risk of loss, or of adverse change in the value of insurance liabilities, resulting from fluctuations in the timing, frequency and

severity of insured events, and in the timing and amount of claim settlements at the time of provisioning (Non-SLT Health). (c) the risk of loss, or of adverse change in the value of insurance liabilities, resulting from the significant uncertainty of pricing and

provisioning assumptions related to outbreaks of major epidemics, as well as the unusual accumulation of risks under such extreme circumstances (CAT Health)

153

SCRSCRhealthhealth

Lapse Risk

Premium & Reserve Risk

HealthNon SLT

HealthSLT

Revision Risk

Expense Risk

Lapse Risk

Disability Risk

Longevity Risk

Mortality Risk

HealthCAT

Pandemic

Mass Accident

Concentration

Health Underwriting Risk (cont)

• Correlations:

• The underlying assumptions for the health underwriting risk module can be summarised as follows:

• It is assumed that the volatility risk component is implicitly covered by the level, trend and catastrophe risk components. This is considered to be acceptable, since volatility risk is thought to be considerably lower than the trend risk.

• The design of the health underwriting risk module has been kept simple by including only the level, trend and catastrophe risk components.

• The underlying assumptions for the SLT Health underwriting risk module as well as for the SLT Health underwriting risk simplified calculations are assumed to be the same as for the life underwriting risk module, with the exception of disability risk for medical expense insurance, SLT Health lapse risk, SLT Health revision risk and the health catastrophe risk modules.

• The underlying assumptions in the Non-SLT Health underwriting risk module are the same as for the non-life underwriting risk module, with the exception of the health catastrophe risk module.

154

rxc cr

rxchealth HealthHealthCorrHealthSCR

CorrHealth HealthSLT HealthNonSLT HealthCAT

HealthSLT 1

HealthNonSLT 0.5 1

HealthCAT 0.25 0.25 1

HealthSLT= SLT Health Risk

• The underlying assumptions for the SLT Health underwriting risk module are assumed to be the same as for the Life underwriting risk module, with the exception of disability risk for medical expense insurance, SLT Health lapse risk, SLT Health revision risk and health catastrophe risk.

• A simplified calculation for health underwriting risk sub-modules (mortality risk, longevity risk, disability-morbidity risk, expense risk, lapse risk) is available for undertakings, where such simplified calculation is proportionate to the nature, scale and complexity of the risks faced and where the standard calculation would lead to an undue burden for the undertaking. The underlying assumptions for the simplified calculation are the same as for the Life underwriting risk sub-modules, except for medical expense disability-morbidity risk.

• Correlations:

where

• HealthmortSLT = as per the Lifemort shock (simplification also may apply).

• HealthlongSLT = as per the Lifelong shock (simplification also may apply).

• HealthexpSLT = as per the Lifeexp shock (simplification also may apply).

155

rxc

SLT

c

SLT

r

SLT

cr,SLT HealthHealthSLTCorrHealthHealth

Mortality Longevity Disability/ morbidity

Lapse Expense Revision

Mortality 1

Longevity -0.25 1

Disability/ morbidity

0.25 0 1

Lapse 0 0.25 0 1

Expense 0.25 0.25 0.50 0.50 1

Revision 0 0.25 0 0 0.50 1

HealthdisSLT

• HealthdisSLT depends upon whether medical insurance or income insurance, as follows:

– Medical expense insurance obligations are obligations which cover the provision of preventive or curative medical treatment or care including medical treatment or care due to illness, accident, disability and infirmity, or financial compensation for such treatment or care. For medical insurance, disability risk shock based upon the maximum additional capital required from a combination of a permanent increase/decrease of claims level of 5% combined with a permanent increase/decrease of claim inflation of 1%.

– Income protection insurance obligations are obligations which cover financial compensation in consequence of illness, accident, disability or infirmity other than obligations considered as medical expenses insurance obligations. For income insurance, disability risk as per the Lifedis shock (simplification also may apply).

• The underlying assumptions for the SLT Health disability-morbidity risk sub-module can be summarised as follows:

• It is assumed that the same parameter assumptions about the trend of health claims (inflation risk) as for the life expense risk sub-module are applicable as there are no indications that the variability of the level of claims differ significantly.

• For estimation risk due to assumptions on the level of claims based on past observations, it is assumed that undertakings estimate the level of claims from the last five years observations. The estimated result is assumed to be appropriate for an average European health (re)insurance portfolio.

• A simplified calculation for health medical expense disability-morbidity risk is available for undertakings, where such simplified calculation is proportionate to the nature, scale and complexity of the risks faced and where the standard calculation would lead to an undue burden for the undertaking. The underlying assumptions for the simplified calculation are that notwithstanding the inflation factor, the amounts of claims taken into account in the calculation of the best estimate for medical expense obligations are constant over time, until the end of the payment period; the effect of discounting on the change in value of the best estimate before and after shock can be neglected; the reinsurance applied to medical expense obligations is proportional, and the application of the shock has no impact on the ability of the reinsurer to pay its quota-share of losses; the average projected inflation rate is close to zero (in practice, no more than 3%); the modified duration of the cash-flows included in the best estimate of the obligations considered is equal (or very close) to the total length of the claims settlement period.

156

HealthlapseSLT , Healthrev

SLT

• The SLT Health lapse risk covers the risk of loss, or of adverse change in the value of (re)insurance liabilities, resulting from changes in the level or volatility of the rates of policy lapses, terminations, renewals and surrenders. Healthlapse

SLT = lapse shock as per the Lifelapse shock except for the up and down shocks use 40% instead of 50%.

• The underlying assumptions for SLT Health lapse risk can be summarized as follows:

• The lapse take-up rates follow a normal distribution.

• The lapse take-up rates are age-independent and a medium lapse shock across age bands produces an appropriate calibration for the minimum floor to assumed lapse rates.

• Option take-up rates by policyholders are assumed higher than the minimum floor under stressed situations.

• For health mass lapse risk, the underlying assumptions are the same as for the life lapse risk sub-module, however excluding the distinction made between non-retail and retail business in policyholder behaviour.

• The SLT Health revision risk covers the risk of loss, or of adverse change in the value of annuity (re)insurance liabilities resulting from fluctuations in the level, trend, or volatility of the revision rates applied to benefits, due to changes in inflation, the legal environment (or court decision); only future changes approved or strongly foreseeable at the calculation date under the principle of constant legal environment, or the state of health of the person insured (sick to sicker, partially disabled to fully disabled, temporarily disabled to permanently disabled). Healthrev

SLT = revision shock as per the Liferev shock but with a 4% shock increase rather than a 3% increase.

157

HealthNonSLT= Non-SLT Health Risk

• The capital charge for Health NonSLT for premium and reserve is calculated on a similar basis to NLpr

• where

VNonSLT Health = Volume measure (for Non-SLT Health (re)insurance obligations)

= Combined standard deviation (for Non-SLT Health (re)insurance obligations) of the reserve and premium risk standard deviation

• Two step process: In a first step, for each segment standard deviations and volume measures for both premium risk and reserve risk are determined and in a second step, the standard deviations and volume measures for the premium risk and the reserve risk are aggregated to derive an overall volume measure.

158

2NonSLTlapse

2NonSLTpr

NonSLT HealthHealthHealth

HealthNonSLTHealthNonSLTNonSLT

Reserve&Premium Vσ3Health

HealthNonSLTσ

HealthNonSLT= Non-SLT Health Risk

• Premium volume measured as per NLpr :

where • NEP by LOB for the t+1 is not materially greater than current year. • Ps = Estimate of NEP for each segment (LOB) during the following 12 months. • P(existing,s)= The expected PV of NEP for each segment after the following 12 months for existing contracts. • P(future,s)= The expected PV of NEP for each segment where the initial recognition date falls in the following 12 months but excluding the premiums to be earned during the 12 months after the valuation date.

• Reserve volume measured as per NLpr: where PCOlob = best estimate for net

claims outstanding for each LOBs.

• The standard deviation for premium & reserve risk by LOB is:

(impact of per risk reinsurance, NP adjustment factor, set at 1)

159

lob

lob)(res, PCOV

LoB Standard deviation for premium risk

(net of reinsurance)

Medical expense 5.0%

Income protection 8.5%

Workers’ compensation 8.0%

Non-proportional health reinsurance

17.0%

LoB Standard deviation for reserve risk (net of

reinsurance)

Medical expense 5%

Income protection 14%

Workers’ compensation 11%

Non-proportional health reinsurance

20%

s)(future,s)(existing,ss)(prem, FPFPPV

HealthNonSLT= Non-SLT Health (cont)

• The standard deviation for premium and reserve risk in the individual LOB is defined by aggregating the standard deviations for both risks under the assumption of a correlation coefficient of 0.50 as follows:

• Moving to step two, the overall volume measure is as follows:

where

and

• where the index j denotes the geographical segments and V(prem,j,l,s) and V(res,j,s) denote the volume measures as defined above but taking into account only insurance and reinsurance obligations where the underlying risk is situated in the geographical segment j.

• DIVs should be set to 1 for segment Non-proportional health reinsurance.

160

lob)(res,lob)(prem,

2

lob)(res,lob)(res,lob)(res,lob)(prem,lob)(res,lob)(prem,

2

lob)(prem,lob)(prem,

(lob)VV

VσVVσ2ααVσσ

lob

lobHealthNonSLT VV

loblob)(res,lob)(prem,lob DIV0.250.75VVV

2

jlob)j,(res,lob)j,(prem,

j

2

lob)j,(res,lob)j,(prem,

lob

VV

VV

DIV

HealthNonSLT= Non-SLT Health (cont)

• The overall standard deviation in step two is as follows:

• The correlation matrix CorrLobNonSLT is as follows:

161

ss

s

rr

rxccrcr

rxcSLTNon

HealthNonSLTV

VVCorrLob

Medical expense

Income protection

Workers’ compensation

NP health reinsurance

Medical expense 1

Income protection 0.5 1

Workers’ compensation

0.5 0.5 1

NP health reinsurance

0.5 0.5 0.5 1

HealthNonSLT= Non-SLT Health (cont)

• When assessing technical provisions, assumptions need to be made on the level of future premiums and the corresponding take-up of options and/or guarantees given in such future premiums. These assumptions need to be stressed and included as a capital charge, as follows:

where:

lapseshock1 = Discontinuance of 40% of the insurance policies for which discontinuance would result in an increase of technical provisions without the risk margin.

lapseshock2 = Decrease of 40% of the number of future insurance or reinsurance contracts used in the calculation of technical provisions associated to reinsurance contracts cover insurance or reinsurance contracts to be written in the future.

• lapseshock1 and lapseshock2 shall apply uniformly to all insurance and reinsurance contracts concerned. In relation to reinsurance contracts lapseshock1 shall apply to the underlying insurance contracts.

• For the purpose of determining the loss in basic own funds of the insurance or reinsurance undertaking under lapseshock1, the undertaking shall base the stress on the type of discontinuance which most negatively affects the basic own funds of the undertaking on a per policy basis.

162

)lapseshockk(lapseshoc |ΔBOFHealth NonSLT 21,lapse

HealthHRES = Risk Equalisation

• Under particular conditions the risk-mitigating effect of health risk equalisation systems (HRES) can be taken into account by way of the fully or partial replacement of standard deviations for premium and reserve risk which are specific for the risk equalisation system whereby:

(a) The mechanism for the sharing of claims is transparent and fully specified in advance;

(b) The mechanism for the sharing of claims, the number of insurance undertakings that participate in the HRES and the risk characteristics of the business subject to the HRES ensure that for each undertaking participating in the HRES the volatility of annual losses of the business subject to the HRES is significantly reduced by means of the HRES;

(c) The health insurance subject to the HRES is compulsory and serves as a partial or complete alternative to health cover provided by the statutory social security system;

(d) In case of default of insurance undertakings participating in the HRES, one or several governments guarantee to fully meet the policyholder claims of the insurance business that is subject to the HRES.

• EIOPA may for the purposes of the preparatory phase determine standard deviations for non-life health premium and reserve risk for the LOBs - medical expense insurance, income protection insurance and workers’ compensation insurance for business - that is subject to a HRES provided that the following conditions are met:

(a) the standard deviations are determined separately for each of the LOB which are subject to the HRES;

(b) the standard deviation for premium risk is an estimate of the representative standard deviation of an insurance undertaking's combined ratio, being the ratio of the sum of the amounts of payments, including the relating expenses, and technical provisions set up for claims incurred during the year for the business subject to the HRES, including any amendments due to the HRES; and the earned premium of the year for the business subject to the HRES.

163

HealthHRES = Risk Equalisation (cont)

c) the standard deviation for reserve risk is an estimate of the representative standard deviation of an insurance undertaking's run-off ratio being the ratio of the difference the BE provision for claims outstanding + IBNR at the beginning of the year and that for the same claims at the end of the year and the BE provision for claims outstanding (including IBNR) at the beginning of the year for the business subject to the HRES.

d) the determination of the standard deviation is based on adequate, applicable and relevant actuarial and statistical techniques.

e) the determination of the standard deviation is based on complete, accurate and appropriate data that is directly relevant for the business subject to the HRES and reflects the diversification at the level of the insurance undertaking.

f) the determination of the standard deviation is based on current and credible information and realistic assumptions.

g) the determination of the standard deviation also takes into account any risks which are not mitigated by the HRES, in particular expense risk and risks which are not reflected in the health catastrophe risk sub-module and that could affect a larger number of insurance undertakings subject to the HRES at the same time.

h) notwithstanding points (a) to (g), the standard deviation of a segment is not lower than one third of the standard deviation specified without the HRES.

• Where not all their business in a line of business lob is subject to the HRES, but only a part of it, undertakings should use a premium risk standard deviation for the calculation of Non-SLT health premium and reserve risk sub-module that is equal to the following where nHRES is for the business not included in the HRES:

164

HRES) lob,(res,nHRES)lob,(prem,

HRES) lob,(res,HRES) lob,(res,nHRES)lob,(prem,lob.nHRES)(prem,

VV

VσVσ

HealthCAT = Health Catastrophe • 3 standardised scenarios (with losses from each scenario are netted down for reinsurance cover):

– Mass accident, accident concentration, pandemic.

• The underlying assumptions for the health catastrophe risk sub-module can be summarised as follows:

• The three health catastrophe risk scenarios (mass accident, accident concentration and pandemic) are assumed to be independent events.

• The scenario based approach for the health catastrophe risk sub- module assumes that the portfolio of the financial statement date is representative for the whole year.

• 1) Mass accident risk sub-module to health (re)insurance obligations other than workers’ compensation insurance and reinsurance obligations resulting in the following impacts:

where

E(e,s) = Total value of benefits payable by (re)insurer for event type e in country s.

rs = Ratio of persons affected by the mass accident in country s, as per exhibit below.

xe = Ratio of persons which will be affected by event type e as the result of the accident.

where the sum includes all insured persons i of the undertaking who are insured against event type e and are inhabitants of country s and SI(e,i) denotes the value of the benefits payable by the undertaking for the insured person i in case of event type e.

165

Xe

Accidental Deaths 10.0%

Permanent Disability 1.5%

Disability lasting 10 years 5.0%

Disability lasting 12 months 13.5%

Medical/Injuries Treatment 30.0% e

seessma ExL ),(),( r

2P

2ac

2ma )(SCR)(SCR)(SCRSCR HealthCAT

s

2sma, )(SCRSCRma

i

iese SIE ),(),(

HealthCAT = Health Cat (cont) – Mass accident risk sub-module - Ratio of persons affected by the mass accident in country s:

• The mass accident scenario captures the risk of having many people in one location at the same time, causing mass accidental deaths, disabilities and injuries with a high impact on the cost of medical treatment sought.

• The underlying assumptions for the health mass accident catastrophe risk sub-module can be summarised as follows:

• It is assumed that the insurance cover is shared amongst a large number of insurance undertakings (which is different from the Health Accident Concentration scenario).

• The scopes of insurance products affected by the scenario are assumed to be limited to products covering Deaths caused by Accidents, Permanent Total Disability, Long Term Disability (lasting 10 years), Short Term Disability (lasting 12 months), and Medical/Injuries treatment. It is assumed that mass accident risk in relation to workers' compensation insurance is not material.

• It is assumed that the undertaking’s exposure to mass accident risk situated in third countries, other than specific European countries is not material. Therefore, the calibration of the ratio of persons affected by the mass accident has only been performed for European countries.

• The proportion of people who will receive benefits under the mass accident scenario has been calibrated based on injury distributions per product type and are assumed to be fixed and the same for each country.

166

Country s rs Country s rs Country s rs

Austria 0.30% Hellenic 0.30% Netherlands 0.15%

Belgium 0.25% Germany 0.05% Norway 0.25%

Bulgaria 0.30% Hungary 0.15% Poland 0.10%

Croatia 0.40% Iceland 2.45% Portugal 0.30%

Cyprus 1.30% Ireland 0.95% Romania 0.15%

Czech 0.10% Italy 0.05% Slovak 0.30%

Denmark 0.35% Latvia 0.20% Slovenia 0.40%

Estonia 0.45% Lithuania 0.20% Spain 0.10%

Finland 0.35% Luxembourg 1.05% Sweden 0.25%

France 0.05% Malta 2.15% Switzerland 0.25%

UK 0.05%

HealthCAT = Health Cat (cont)

• 2) Accident Concentration aims to capture the risk of having concentrated exposures, the largest of which is being affected by a disaster. For example: a disaster within densely populated office blocks in a financial hub.

– Cc = The largest accident risk concentration of (re)insurer in country c

– xe = Ratio of persons which will receive benefits of event type e as a result of the accident

– Ne = Number of insured persons of the (re)insurer which are insured against event type e and which belong to the largest accident risk concentration of the insurance or reinsurance undertaking in country c

– SI(e,i) = Value of the benefits payable by the (re)insurer for the insured person i in case of event type e.

– For all countries, the largest accident risk concentration of a (re)insurer in a country c shall be equal to the largest number of persons for which the following conditions are met:

(a) the (re)insurer has a workers' compensation insurance or reinsurance obligation or an group income protection insurance or reinsurance obligation in relation to each of the persons.

(b) the obligations in relation to each of the persons cover at least one of the events set out in MA above. (c) the persons are working in the same building which is situated in country c.

167

s

2sac, )(SCRSCRac

e

ceeccac CExL ),(),( C

eN

i

iee

ce SIN

CE1

),(),( 1

HealthCAT = Health Cat (cont)

• 2) Accident Concentration(cont)

– The value of the benefits shall be the sum insured or where the insurance contract provides for recurring benefit payments the best estimate of the benefit payments in case of event type e. Where the benefits of an insurance contract depend on the nature or extent of any injury resulting from event e, the calculation of the value of the benefits shall be based on the maximum benefits obtainable under the contract which are consistent with the event. For medical expense insurance and reinsurance obligations the value of the benefits shall be based on an estimate of the average amounts paid in case of event e, assuming the insured person is disabled for the duration specified and taking into account the specific guarantees the obligations include.

– The accident concentration scenario captures the risk of having concentrated exposures due to densely populated locations, causing concentrations of accidental deaths, disabilities and injuries in the event of the scenario as applies also to mass accident catastrophe risk. The underlying assumptions for the health accident concentration Catastrophe risk sub- module can be summarized as follows:

• It is assumed that the insurance cover is shared amongst only a limited number of insurance undertakings (which is different from the Health Mass Accident scenario).

• The scope of insurance products affected by the scenario is assumed to be limited to products covering Deaths caused by Accident, Permanent Total Disability, Long Term Disability (lasting 10 years), Short Term Disability (lasting 12 months), and Medical/Injuries treatment. The same calibration is used as for mass accident catastrophe risk. It is assumed that accident concentration risk in relation to medical expense insurance and income protection insurance other than group contracts is not material to the undertaking.

• The accident concentration scenarios are applicable to worldwide exposures. It is assumed that undertakings have information on the largest accident risk concentration value and the average value of benefits payable for the largest accident risk concentration for the countries they are exposed to.

• The proportion of people who will receive benefits under the scenario has been calibrated based on injury distributions per product type and are assumed to be fixed and the same for each country.

168

HealthCAT = Health Cat (cont)

• 3) Pandemic Risk aims to capture the risk that there could be a pandemic that results in non lethal claims, e.g. where victims infected are unlikely to recover and could lead to a large disability claim. It will impact:

– disability income (both long and short term).

– products covering permanent and total disability either as a stand alone benefit or as part of another product, such as a stand alone critical illness product.

– Medical expenses insurance.

– Nc = Number of insured persons of (re)insurer which are inhabitants of country c and are covered by medical expense insurance or reinsurance obligations, other than workers' compensation insurance or reinsurance obligations, that cover medical expenses resulting from an infectious disease.

– CH(h,c) = Best estimate of the amounts payable by (re)insurer for an insured person in country c in relation to medical expense insurance or reinsurance obligations, other than workers' compensation obligations, for healthcare utilisation h in the event of a pandemic.

– Hh = Ratio of persons with clinical symptoms which will utilise healthcare of type h. – E = Income protection pandemic exposure of (re)insurer.

where the sum includes all insured persons i covered by the income protection cover than WC obligations and Ei denotes the value of the benefits payable, for the insured person i in case of a permanent work disability caused by an infectious disease. The value of the benefits shall be the sum insured or where the contract provides for recurring benefit payments the BE of the benefit payments assuming that the insured person is permanently disabled and will not recover.

169

h

chhc CHHM ),( c

ccp MNEL 4.00.000075

i

iEE

Hh

Hospitalisation 1%

Doctor consult 20%

No medical care 79%

HealthCAT = Health Cat (cont)

• 3) Pandemic Risk (cont)

The pandemic scenario captures the risk of having a large number of non-lethal disability and income protection claims and where victims are unlikely to recover as a result of a pandemic. The scenario is different from the Life Catastrophe scenario where mass mortality is assumed to occur. The underlying assumptions for the health pandemic catastrophe risk sub- module can be summarized as follows:

• It is assumed that the insurance cover is shared amongst only a limited number of insurance undertakings.

• The scope of insurance products affected by the pandemic scenario is assumed to be limited to Long Term Disability (lasting 10 years) products.

• The proportion of disabilities following a pandemic event, the proportion of affected people that survive, and the proportion of people thereof that become chronically disabled in a one of two hundred years event is not higher than the proportions for the Encephalitis Lethagica (EL) pandemic.

• The pandemic catastrophe scenarios are applicable to worldwide exposures. It is assumed that undertakings have information on the number of insured persons covered by medical expense insurance other than workers' compensation that cover medical expenses from an infectious disease and the expected average value of benefits payable in case of a pandemic for the countries they are exposed to.

• The ratio of persons with clinical symptoms which will utilize a certain type of healthcare under the pandemic scenario has been calibrated based on disability distributions per product type and are assumed to be fixed and the same for each country.

170

Section 3: MCR & Own FundsSection 3: MCR & Own Funds

MCR Calculation

AMCR = €2.5M non-life insurers (including captives) or €3.7M if classes 10 to 15 covered. = €3.7M life insurers.

= €3.6M reinsurers (except reinsurance captives = €1.2M). where Non-Life: where αj and βj as per table in the next slide, and TP and P are net technical provisions (excluding risk margin and minimum of

0) and previous 12 month written premium for each LOB. Life: where CAB is capital at risk and TP is net technical provisions (excluding risk margin) as follows:

• TP(life,1) = guaranteed benefits for life insurance obligations with profit participation, with a floor equal to zero. • TP(life,2) = future discretionary benefits for life insurance obligations with profit participation, with a floor equal to 0. • TP(life,3) = index-linked and unit-linked life insurance obligations , with a floor equal to zero. • TP(life,4) = all other life insurance and reinsurance obligations, with a floor equal to zero.

Composite: A weighted average, based upon the applicable AMCR, is calculated whereby the supervisory body approves the capital add-

on required for the non-life or life minority business segment. 172

AMCR;MCR maxMCR combined

SCR0.45;SCR0.25;MCRmax min MCR linearcombined

Llinear MCR

NLlinear MCR

linearMCR

j

NLlinear jPjβ;jjαmaxMCR TP

CAR.TPTPTP0.037 MCR life,3life,21 life,L Linear, 0007.0021.0007.0052.0 life,4TP

MCR Calculation (cont)

Non-life table:

173

j Line of business αj βj

A.1 Medical Expense insurance and proportional reinsurance 4.7% 4.7%

A.2 Income Protection insurance and proportional reinsurance 13.1% 8.5%

A.3 Workers Compensation insurance and proportional reinsurance 10.7% 7.5%

A.4 Motor vehicle liability and proportional reinsurance 8.5% 9.4%

A.5 Motor, other classes insurance and proportional reinsurance 7.5% 7.5%

A.6 Marine, aviation, transport insurance and proportional reinsurance 10.3% 14.0%

A.7 Fire and other property damage insurance and proportional reinsurance 9.4% 7.5%

A.8 General liability insurance and proportional reinsurance 10.3% 13.1%

A.9 Credit and suretyship insurance and proportional reinsurance 17.7% 11.3%

A.10 Legal expenses insurance and proportional reinsurance 11.3% 6.6%

A.11 Assistance and proportional reinsurance 18.6% 8.5%

A.12 Miscellaneous financial loss insurance and proportional reinsurance 18.6% 12.2%

A.13 NP reinsurance – property 18.6% 15.9%

A.14 NP reinsurance – casualty 18.6% 15.9%

A.15 NP reinsurance – MAT 18.6% 15.9%

A.16 NP reinsurance – health 18.6% 15.9%

Owns Funds for SCR & MCR

174

SCRSCR

Min 50%- Max 100% Tier 1

Minimum level of restricted Tier 1

= 20% of total Tier 1

Min 0%- Max 50% Tier 2

Min 0%- Max 15% Tier 3

MCRMCR 25% to 45%

of SCR

Min 80%- Max 100% Tier 1

Minimum level of restricted Tier 1

= 20% of total Tier 1

Min 0%- Max 20% Tier 2 Basic

Owns Funds – Tier 1 Basic Tier 1 = Assets in excess of liabilities that are in 6 items listed and paid-in subordinated liabilities (both as per SII valuation).

1) Paid-in ordinary share capital and the related share premium account. 2) Paid-in initial funds, members' contributions or the equivalent basic own-fund item for mutual and mutual-type

undertakings. 3) Paid-in subordinated mutual member accounts. 4) Surplus funds that are not considered insurance liabilities in accordance with Article 91(2) of SII Directive (e.g.

Surplus on with profits business). 5) Paid-in preference shares and the related share premium account. 6) Reconciliation reserve – including items such as foreseeable dividends and expected profit in future premium.

Restricted Tier 1 = Anything in the list above which does not meet the criteria above is restricted.

Note: More clarity on Tier 1 items may be provided in Level II Delegated Acts and other material yet to be finalised.

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Criteria - Deeply subordinated - After the claims of all policy holders and beneficiaries and non-subordinated creditors and after all other claims in the event of winding-up proceedings. - Absence of features causing or accelerating insolvency – No contractual feature to petition for insolvency in the absence of distribution or demand or compensation rights. - Immediately available to absorbs loss - At a minimum of when SCR breached. Also does not hinder re-capitalisation or require new capital to be subordinated. - Duration - Maturity at least equal to that of the undertaking’s liabilities for ordinary shares & minimum 5 years before option - to repay or redeem. - Repayment or redemption and absence of incentives to redeem - Only have option to repay or redeem during 5-10 years if sufficient margin above SCR for medium term capital management plan and subject to supervisory approval. - Suspension of repayment or redemption - Where SCR breached without penalty. Also cancellation of distributions in case of non-compliance with the SCR (<=75%) with any subsequent distributions under pre-agreed circumstances. - Full discretion over distributions - Insurer have full discretion over any repayment or redemption payments. - Free of any encumbrances - Including rights of offset, restrictions, charges, or guarantees.

Owns Funds – Tier 2 & 3

Tier 2 Basic = Basic own fund items not classified as unrestricted or restricted basic Tier 1. Some differences to Tier 1 may be allowed such as limited incentives to repay after 10 years with limited coupon step-ups (e.g. 100 bps or 50% of initial spread).

Tier 2 Ancillary = items, other than basic own funds, which are subject to prior supervisory approval, including

• Uncalled & unpaid share capital,

• LOCs or guarantees (for current assessment such item held in trust by an independent trustee for the benefit of creditors and provided by a credit institution, as per CRD Directive, are eligible without prior supervisory authority approval),

• Other legally binding commitments from (re)insurers that if called & paid would be Tier1.

Tier 3 Basic = Basic own fund items not classified as basic Tier 1 or 2. Items to be considered here may include subordinated mutual members accounts, share premium account, preference share and net deferred tax assets.

Tier 3 Ancillary = Any item that does not fall into Tier 2 ancillary as if called & paid up would not meet Tier 1 requirements.

As a transitional arrangement the following items can be used for up to 10 years from the introduction of Solvency II:

– BOF that could have been used to meet up to 50% of the solvency margin can be treated as Tier 1 basic own funds. – BOF items that could have been used to meet up to 25% of the solvency margin can be treated as Tier 2 basic own funds.

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Section 4: MiscellaneousSection 4: Miscellaneous

Ring Fenced Funds

• A ring-fenced fund arises as a result of the restriction on a going concern basis of own funds items so that they can only be used to cover losses: (i) on a defined portion of the undertaking’s insurance contracts, (ii) in respect of certain policyholders or beneficiaries, or (iii) arising from particular risks.

• The existence of a restriction on assets in relation to liabilities which would lead to restricted own funds is the defining characteristic of a ring-fenced fund. Examples of the reasons for such restrictions include: (1) contractual terms in a policy or that apply to a number of policies, or a separate legal arrangement that applies in addition

to the terms of a policy. (2) provisions in the articles of association or statutes of the undertaking: national legislation or regulations in respect of

product design or the conduct of the relationship between undertakings and their policyholders: provisions of EU law, whether transposed or directly applicable: or arrangements specified by order of a court or other competent authority which require separation of or restrictions on assets or own funds in order to protect one or more groups of policyholders.

• Profit participation is not a defining characteristic although it may be present. • The ring-fenced assets and liabilities should form an identifiable unit within the undertaking although they may not necessarily

be subject to separate management. • As a minimum, the undertaking has to compare arrangements within its business with the following types of ring-fenced funds

as part of its identification of characteristics and restrictions giving rise to ring-fenced funds: (i) With-profits where policyholders within the ring-fenced fund have distinct rights relative to other business written by the

insurer and there are restrictions on the use of assets, and the return on such assets, within this fund to meet liabilities or losses arising outside the fund and where there is generally profit participation within the ring-fenced fund whereby policyholders receive a minimum proportion of the profits generated in the fund which are distributed through additional benefits or lower premium, and, if relevant, shareholders may then receive the balance of such profits.

(ii) Legally binding arrangement or trust created for the benefit of policyholders. This could fall within SCR.10.12. (i) or (ii), where, within or separate to the policy documentation, an agreement calls for certain proceeds or assets to be placed in trust or subject to a legally binding arrangement or charge for the benefit of the specified policyholders.

(iii) Provisions in the articles of association or statutes of the undertaking: The ring-fenced fund would reflect the restrictions on particular assets or own funds as specified in the articles of association or statutes of the undertaking.

(iv) National legislation: This covers the situation where a ring-fenced fund would arise to reflect the effect of restrictions or arrangements specified in national law.

(v) EU law: This will include arrangements falling within the scope of the Solvency II framework.

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Ring Fenced Funds (cont)

• Arrangements and products that are generally outside the scope of ring-fenced funds:

– Conventional unit-linked products where benefits are directly linked to the value of units in an UCITS or to the value of assets contained in an internal fund held by the (re)insurer, usually divided into units.

– Conventional index-linked products where all of the benefits provided by a contract are based on a share index or some other reference value.

– Provisions (including technical provisions, equalisation provisions) and reserves set up in accounts or financial statements prepared under the requirements applying in a particular jurisdiction. Such items do not constitute ring-fenced funds solely by virtue of being set up in such financial statements.

– Conventional reinsurance business, to the extent that individual contracts do not give rise to restrictions on the assets of the undertaking.

– Coverage assets or similar arrangements set up for the protection of policyholders in the case of winding-up proceedings, either for the policyholders as a whole, separate sections or groups of policyholders.

– Separation of life and non-life business in composite undertakings which carry out simultaneously life and non-life and/or health insurance activities set out in Articles 73 and 74 of the Directive.

– Surplus funds are not ring-fenced solely by virtue of being surplus funds unless generated within a ring-fenced fund.

– Temporary ring-fencing of assets as part of a transfer of a portfolio during a business re-organisation.

– Experience funds, where policyholders are entitled to a share of the experience of the fund in a manner, typically a minimum predefined percentage, set out in the policy documentation, and have no rights to any amounts not allocated in accordance with that specified profit-sharing mechanism.

179

Ring Fenced Funds (cont)

• A notional SCR has to be calculated for these ring-fenced funds and the remaining business as if they were separate undertakings:

– The capital requirement at the level of each ring-fenced fund is calculated net of the mitigating effect of future discretionary benefits (with loss absorbing capacity restricted to the amount of future discretionary benefits within that fund).

– Where profit participation exists, the assumptions on the variation of future bonus rates have to be realistic with due regard to the impact of the shock at the level of the ring-fenced fund and to any contractual, legal or statutory requirements governing the profit participation mechanism.

– The notional SCR must include a capital requirement for operational risk as well as any relevant adjustments for the loss-absorbing capacity of technical provisions and deferred taxes.

– The notional SCR for each ring-fenced fund is determined by aggregating the ring-fenced funds’ capital requirements for each sub-module and risk module of the BSCR as if a separate entity. Diversification of risks within the ring-fenced fund is permitted.

– An adjustment to the reconciliation reserve is required for restricted own-fund items in a ring-fenced fund (such restricted own-fund items exclude the value of future transfers attributable to shareholders).

– Adjustment to Own Funds:

• Excess restricted own-fund items over the notional SCR is excluded from the amount of own-fund items eligible to cover the SCR and the amount of basic own-fund items eligible to cover the MCR.

• If restricted own funds within a ring-fenced fund is equal to or less than the notional SCR of the ring-fenced fund, no adjustment to own funds is made. In this case, all of the own funds within the ring-fenced fund are available to meet the SCR and MCR.

– SCR for undertaking as a whole = sum of notional SCR from ring fenced funds + notional SCR for the rest of undertaking’s business. No diversification benefits between ring fenced funds and/or remaining business and any negative notional SCR set to zero.

180

Risk Mitigation Principles

• Principle 1: Economic effect over legal form – Recognised and treated consistently, regardless of their legal form or accounting treatment. Any material new risks

shall be identified, quantified and included within the SCR. No double counting of mitigation effects in recognition.

• Principle 2: Legal certainty, effectiveness and enforceability – Clear & applicable documentation covering all of transaction (including related documents) that reflects the economic

substance of the transaction. No terms or conditions which allow for unilaterally cancellation, changes of terms, or imposition of additional costs by 3rd party

– “On-going enforceability” refers to any legal or practical constraint that may impede the undertaking from receiving the expected protection.

– Only protection available at the date of reference of the solvency assessment allowed.

• Principle 3: Liquidity and certainty of value – Valued in line with the valuation principles for assets and liabilities. – Must be written policies in undertaking on its liquidity requirements.

• Principle 4: Credit quality of the provider of risk mitigation

– Credit quality must be adequate & assessed using objective techniques according to generally accepted practices. – Correlation between the values of the instruments relied upon for risk mitigation and the credit quality of their

provider shall not be unduly adverse, i.e. it should not be materially positive (known in the banking sector as ‘wrong way risk’). [This does not refer to the systemic risk of financial sector].

• Principle 5: Direct, explicit, irrevocable and unconditional features

– Only reduce SCR if technique provides the undertaking with a direct claim on the protection provider, contain an explicit reference to specific exposures or a pool of exposures, so that the extent of the cover is clearly defined and incontrovertible, not subject to a clause amending terms & conditions whereby fulfilment is outside the direct control of the undertaking.

181

Financial Risk Mitigation

• A ‘financial risk mitigation technique’ is a financial contract whose future value or future cash flows vary in opposite direction and equivalent, or sufficiently similar, amount to the variations of the future value or future cash flows of the assets or liabilities considered by the undertaking in its solvency assessment.

• Subject to 5 risk mitigation principles. Specifically arrangement must be legally effective and enforceable, the (re)insurer has taken all steps to ensure its effectiveness and monitors same, and has a direct claim on the counterparty in the event of default, insolvency or bankruptcy.

• The calculation of the SCR using the standard formula should allow for the effects of risk mitigation techniques through a reduction in requirements commensurate with the extent of risk mitigation and an appropriate treatment of any corresponding risks embedded in the use of financial risk mitigation techniques. These two effects should be separated.

• No double counting of mitigation effects in both own funds and the calculation of the SCR or within the calculation of the SCR.

• Undertakings should not in their use of risk mitigation techniques anticipate the shocks considered in the SCR calculation. The SCR is intended to capture unexpected risks.

• The calculation should be made on the basis of assets and liabilities existing at the date of reference of the solvency assessment and the risk mitigating technique being in force for at least the next 12 months or in case it will be in force for a period shorter than 12 months it will be taken into account prorata temporis for the shorter of the full term of the risk exposure covered or the period that the risk mitigation technique is in force.

• Where contractual arrangements governing the risk-mitigation techniques will be in force for a period shorter than the next 12 months and the undertaking intends to replace that risk-mitigation technique at the time of its expiry with a similar arrangement, the risk-mitigation technique shall be fully taken into account in the BSCR provided the following qualitative criteria are met: (a) The undertaking has a written policy in the replacement of that risk-mitigation technique. (b) The replacement of the risk-mitigation technique shall not take place more often than every three months. (c) The replacement of the risk-mitigation technique is not conditional on any future event, which is outside of the control

of the undertaking. Where the replacement of the risk-mitigation technique is conditional on any future event, that is within the control of the undertaking, then the conditions should be clearly documented in the written policy referred to in point (a).

(d) The replacement of the risk-mitigation technique shall be realistic based on replacements undertaken previously by the undertaking and consistent with its current business practice and business strategy.

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Financial Risk Mitigation(cont)

e) The risk that the risk-mitigation technique cannot be replaced due to an absence of liquidity in the market is not material. f) The risk that the cost of replacing the risk-mitigation technique increases during the following 12 months is reflected in

the SCR. g) the replacement of the risk-mitigation technique would not be contrary to requirements that apply to future

management actions.

• With the exception of rolling hedging programmes, risk mitigation techniques (for example financial stop-loss processes) not in place at the date of reference of the solvency assessment should not be allowed to reduce the calculation of the SCR with the standard formula.

• The contractual arrangement shall not result in material basis risk or in the creation of other risks. Basis risk is material if it leads to a misstatement of the risk-mitigating effect on the undertaking's BSCR that could influence the decision-making or judgement of the intended user of that information, including the supervisory authorities. Undertakings shall ascertain that they are able to provide sufficient evidence on the fulfilment of the requirements according to the following principles: a) the materiality of the basis risk shall be assessed with reference to the exposure covered by the risk-mitigation technique

and the risk exposure of the insurance or reinsurance undertaking, without considering other elements of the balance sheet, unless any other element keeps a continuous and necessary connection with the risk exposure of the undertaking.

b) the similarity of the nature of the exposures shall be assessed taking into account at least the type of instruments or arrangements involved, their terms and conditions, the rules governing the markets where their prices are derived, and a comparison with other risk-mitigation techniques having the same nature as the risk exposure.

c) The assessment should refer to the behaviour of both exposures under the scenario considered in the relevant risk module or sub-module of the SCR, keeping in mind that such scenarios represent an event aimed to achieve the 99.5th confidence level. In addition, the assessment shall allow at least for:

1) The degree of symmetry among both exposures. 2) Any non-linear dependencies under the relevant scenario. 3) Any relevant asymmetry of the behaviours in case of bi-directional scenarios. 4) The levels of diversification of each respective exposure. 5) Any relevant risks not captured explicitly in the standard formula. 6) The whole payout distribution applying to the risk-mitigation technique.

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Financial Risk Mitigation (cont)

• Rolling & Dynamic hedging: – Protection should be pro-rata to time in place over next 12 months. – Where rolling hedging programme exists, permitted if:

• There is written policy for the replacement of the risk-mitigation technique. • The risk that the hedge can not be rolled over due to an absence of liquidity in the market is not material (no

material liquidity risk). • The costs of renewing the same hedge over a 1 year period as well as risk of replacement costs increasing are

reflected in the SCR calculation by reducing the level of protection of the hedge. • Any additional counterparty risk that arises from rolling over of the hedge is reflected in the SCR. • The replacement of the risk-mitigation technique is not conditional on any future event, which is outside of the

control of the undertaking. – Dynamic hedging should not be treated as a risk mitigation technique.

• Credit Derivatives:

– Reduction of the SCR based on the mitigation of credit exposures by using CDS only allowed where undertakings have in force generally applied procedures for this purpose and consider generally admitted criteria. Requirements set out in other financial sectors for the same mitigation techniques may be considered as generally applied procedures and admitted criteria.

– Mismatch between reference and underlying undertaking in CDS only permitted if: • the reference obligation or the obligation used for the purposes of determining whether a credit event has

occurred, as the case may be, ranks pari passu with or is junior to the underlying obligation; and • the underlying obligation and the reference obligation or the obligation used for the purposes of determining

whether a credit event has occurred, as the case may be, share the same obligor (i.e. the same legal entity) with legally enforceable cross-default or cross-acceleration clauses.

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Insurance Risk Mitigation

• A ‘insurance risk mitigation technique’ includes the use of reinsurance contracts and SPVs which transfer underwriting risks. Reinsurance covered by SII definition (maintains wording of activity of “accepting risks ceded”). Underwriting risk defined in SII as “the risk of loss or of adverse change in the value of insurance liabilities, due to inadequate pricing and provisioning assumptions”.

• Subject to risk mitigation principles 1 through 5. Additionally must be legally enforceable and must be an effective transfer of risk to a 3rd party that can be monitored by the undertaking. Undertaking has a direct claim on the counterparty in the event of default, insolvency or bankruptcy.

• The calculation of the SCR using the standard formula should allow for the effects of risk mitigation techniques through a reduction in requirements commensurate with the extent of risk mitigation and an appropriate treatment of any corresponding risks embedded in the use of financial risk mitigation techniques. These two effects should be separated.

• No double counting of mitigation effects in both own funds and the calculation of the SCR or within the calculation. • Undertakings should not in their use of risk mitigation techniques anticipate the shocks considered in the SCR calculation.

The SCR is intended to capture unexpected risks. • The calculation should be made on the basis of assets and liabilities existing at the date of reference of the solvency

assessment and the risk mitigating technique being in force for at least the next 12 months or in case it will be in force for a period shorter than 12 months it will be taken into account prorata temporis for the shorter of the full term of the risk exposure covered or the period that the risk mitigation technique is in force.

• Where contractual arrangements governing the risk-mitigation techniques will be in force for a period shorter than the next 12 months and the undertaking intends to replace that risk-mitigation technique at the time of its expiry with a similar arrangement, the risk-mitigation technique shall be fully taken into account in the BSCR provided the qualitative criteria for financial risk mitigation are met.

• The contractual arrangement shall not result in material basis risk or in the creation of other risks. Basis risk is material if it leads to a misstatement of the risk-mitigating effect on the undertaking's BSCR that could influence the decision-making or judgement of the intended user of that information, including the supervisory authorities. Particular attention may be required for any currency mismatch, up to a maximum of 25% of capacity of non-proportional reinsurance contract or SPV contract.

• Counter-party must be subject to SII or equivalent framework or, if non-EEA and non-equivalent, a minimum of grade A (based upon financial information no more than 12 months old).

• Finite reinsurance as defined shall only be recognised in SCR to the extent underwriting risk is transferred. 185

Simplifications for Captives

• SCR Counterparty Risk

If an explicit, legally effective and enforceable guarantee by the captive owner for the liabilities of the captive exists, then the credit quality step of the guarantor instead of the captive may be used

• in the calculation of the SCR counterparty default risk module for the ceding undertaking and

• in the calculation of the adjustment for expected losses due to counterparty default for the recoverables towards the captive.

• Cut-through Liability Clause -

Captives’ ceding undertakings may consider the probability of default of the retroceding undertakings of a captive if a legally effective and enforceable ‘cut-through-liability’ clause exists or a similar binding agreement, for the amounts involved in the transactions with the captive. These amounts can be adjusted accordingly in the counterparty default risk module calculation of the ceding undertaking.

186

Participations

187

188

System of Governance (SOG)

Group Supervision

189

EEA insuranceEEA insurance Holding Co.Holding Co.

EEA Insurance Companies

Non-EEA Insurance Companies

Ultimate InsuranceUltimate Insurance Holding CoHolding Co

NonNon--EEA CountryEEA Country

Non-EEA Insurance Co.

Worldwide Group

EEA Group

EEA Insurance Sub-groups

Group Supervision (cont)

• In order to assess group solvency, it is necessary to determine the amount of group own funds which are eligible to cover the group SCR. This assessment has to be made after the elimination of double use of eligible own funds within the group irrespective of the calculation methods (method 1, D&A or combination of methods). The assessment needs to consider the availability of the own funds of each related (re)insurance undertaking, ancillary service undertaking, special purpose vehicle, insurance holding company and mixed financial holding company within the scope of group solvency. This means that own funds that cannot be made either fungible (i.e. absence of dedication to absorb only certain losses) or transferable (i.e. absence of significant obstacles to moving own funds items from one entity of the group to another) for the group within a maximum of 9 months cannot be considered effectively available at group level.

Method 1 - Default method - Accounting Consolidation-based method. • SCR calculated on the basis of (fully and proportionally) consolidated data • Additional guidance provided on adjustments for loss absorbing capacity of technical provisions, deferred taxes and assets,

currency, ring-fenced funds and matching adjustment for consolidated based method.

Method 2 – Deduction & Aggregation method. • To be used where Method 1 for a related undertaking overly burdensome. Under this method, rather than applying the

standard formula to the consolidated data, group solvency is assessed through the sum of the solo solvency capital requirements and own funds of the participating undertaking and of the proportional share of its related undertakings.

• This should include third country insurance undertakings as well as insurance holding companies and mixed financial holding companies. Where non-EEA entity within EEA Group and jurisdiction under consideration for equivalence or on transitional list, then may used local requirements with D&A method.

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AppendicesAppendices

Appendix 1: IFRS-SII Possible Adjustments

192

Applicable Standard Consistent/Adjustment

IAS 2 Inventories Net realisable value is a consistent option. Adjustment may be needed where estimated cost are material.

IAS 12 Income taxes Consistent measurement principles for current taxes. Consistent measurement principles for deferred taxes calculated based on the temporary difference between Solvency II values and the tax values.

IAS 16 Property, plant and equipment Revaluation model is a consistent option.

IAS 17 Leases Consistent measurement principles for operating leases, and, lessors in finance leases. Adjustments needed for lessees in finance leases.

IAS 19 Employee benefits Consistent measurement principles for employee benefits.

IAS 20 Accounting for government grants and disclosure of governance assistance

Fair value for monetary and monetary government grants is consistent with Art. 75.

IAS 21 The effects of changes in foreign exchange rates Translation in reporting currency is consistent with Article 75 of Directive 2009/138/EC.

IAS 28 Investments in Associates and Joint Ventures Applicable equity method principles.

IAS 37 Provisions, contingent liabilities and contingent assets Consistent measurement principles for provisions. Material contingent liabilities are to be recognised as liabilities.

IAS 38 Intangible assets Revaluation model is a consistent option. Goodwill = zero.

Appendix 1: IFRS-SII Possible Adjustments (cont)

193

Applicable Standard Consistent/Adjustment

IAS 39 Financial Instruments: Recognition and Measurement

Fair value measurement principles applied to financial assets are consistent. In case of financial liabilities adjustment might be needed if the IFRS fair value includes changes in own credit standing in subsequent periods.

IAS 40 Investment property Fair value model is a consistent option.

IAS 41 Agriculture Fair value less costs to sell is a consistent option where estimated cost to sell are not material.

IFRS 2 Share-based payments Consistent measurement principles

IFRS 13 Fair Value Measurement IFRS 13 is consistent with Article 75 of Directive 2009/138/EC except for the requirement to reflect the effect of an entity’s own credit.

Appendix 2: Definitions

• Related Undertaking: an undertaking is related to another undertaking if it

(i) is a subsidiary of the other undertaking, or is an undertaking in which the other undertaking holds a participation, or

(ii) is linked to the other undertaking by means of a relationship as defined by Article 12(1) of the Group Consolidated Accounts Directive. GCA Directive defines linked as

– Whereby that undertaking and one or more other undertakings with which it is no connection but that are managed on a unified basis pursuant to a contract concluded with that undertaking or provisions in the memorandum or articles of association of those undertakings; or

– Whereby the administrative, management or supervisory bodies of that undertaking and of one or more other undertakings with which it is not connected consist for the major part of the same persons in office during the financial year and until the consolidated accounts are drawn up.

• Participating Undertaking: an undertaking that is

(a) a parent undertaking or other undertaking that holds a participation, or

(b) an undertaking that is linked to another undertaking by means of a relationship as defined by Article 12(1) of the Group Consolidated Accounts Directive;

• “Participation” means participation within the meaning of Article 17 of the Company Accounts Directive or the holding, directly or indirectly, of 20% or more of the voting rights or capital of an undertaking;

– For the purposes of CA Directive, "participating interest" shall mean rights in the capital of other undertakings, whether or not represented by certificates, which, by creating a durable link with those undertakings, are intended to contribute to the company's activities. The holding of part of the capital of another company shall be presumed to constitute a participating interest where it exceeds a percentage fixed by the Member States which may not exceed 20%.

194

Appendix 3: Non-Life Segmentation A. Non-life insurance obligations 1) Medical expense insurance - Medical expense insurance obligations where the underlying business is not pursued on a similar technical basis

to that of life insurance, other than obligations included in the LOB 3. 2) Income protection insurance - Income protection insurance obligations where the underlying business is not pursued on a similar technical

basis to that of life insurance, other than obligations included in the LOB 3. 3) Workers' compensation insurance - Health insurance obligations which relate to accidents at work, industrial injury and occupational diseases

and where the underlying business is not pursued on a similar technical basis to that of life insurance. 4) Motor vehicle liability insurance - Insurance obligations which cover all liabilities arising out of the use of motor vehicles operating on land

(including carrier's liability). 5) Other motor insurance - Insurance obligations which cover all damage to or loss of land vehicles (including railway rolling stock). 6) Marine, aviation and transport insurance - Insurance obligations which cover all damage or loss to sea, lake, river and canal vessels, aircraft,

and damage to or loss of goods in transit or baggage irrespective of the form of transport. Insurance obligations which cover liabilities arising out of the use of aircraft, ships, vessels or boats on the sea, lakes, rivers or canals (including carrier's liability).

7) Fire and other damage to property insurance - Insurance obligations which cover all damage to or loss of property other than those included in the LOB 5 and 6 due to fire, explosion, natural forces including storm, hail or frost, nuclear energy, land subsidence and any event such as theft.

8) General liability insurance - Insurance obligations which cover all liabilities other than those in the LOB 4 and 6. 9) Credit and suretyship insurance - Insurance obligations which cover insolvency, export credit, instalment credit, mortgages, agricultural credit

and direct and indirect suretyship. 10) Legal expenses insurance - Insurance obligations which cover legal expenses and cost of litigation. 11) Assistance - Insurance obligations which cover assistance for persons who get into difficulties while travelling, while away from home or while

away from their habitual residence. 12) Miscellaneous financial loss - Insurance obligations which cover employment risk, insufficiency of income, bad weather, loss of benefit,

continuing general expenses, unforeseen trading expenses, loss of market value, loss of rent or revenue, indirect trading losses other than those mentioned above, other financial loss (non-trading) as well as any other risk of non-life insurance not covered by the LOB 1 to 11.

B. Proportional non-life reinsurance obligations • The LOB 13 to 24 shall include proportional reinsurance obligations which relate to the obligations included in LOB 1 to 12 respectively.

C. Non-proportional non-life reinsurance obligations 13) Non-proportional health reinsurance - Non-proportional reinsurance obligations relating to insurance obligations included in LOB 1 to 3. 14) Non-proportional casualty reinsurance - Non-proportional reinsurance obligations relating to insurance obligations included in LOB 4 and 8. 15) Non-proportional marine, aviation and transport reinsurance - Non-proportional reinsurance obligations relating to insurance obligations

included in LOB 6. 16) Non-proportional property reinsurance - Non-proportional reinsurance obligations relating to insurance obligations included in LOB 5, 7 & 9-

12. 195

Appendix 4: Life Segmentation

D. Life insurance obligations

17) Health insurance - Health insurance obligations where the underlying business is pursued on a similar technical basis to that of life insurance, other than those included in line of business 33.

18) Insurance with profit participation - Insurance obligations with profit participation other than obligations included in line of business 33 and 34.

19) Index-linked and unit-linked insurance - Insurance obligations with index-linked and unit-linked benefits other than those included in lines of business 33 and 34.

20) Other life insurance - Other life insurance obligations other than obligations included in lines of business 29 to 31, 33 and 34.

21) Annuities stemming from non-life insurance contracts and relating to health insurance obligations.

22) Annuities stemming from non-life insurance contracts and relating to insurance obligations other than health insurance obligations.

E. Life reinsurance obligations

23) Health reinsurance - Reinsurance obligations which relate to the obligations included in lines of business 29 and 33.

24) Life reinsurance - Reinsurance obligations which relate to the obligations included in lines of business 30 to 32 and 34

196

Appendix 5: Health Segmentation

• Health insurance which is pursued on a similar technical basis to that of life insurance (SLT Health) as follows:

– Health insurance obligations should be assigned to life insurance lines of business where such obligations are exposed to biometrical risks (i.e. mortality, longevity or disability/morbidity) and where the common techniques used to assess such obligations explicitly take into consideration the behaviour of the variables underlying these risks. Assigned to one of following:

• Insurance contracts with profit participation where the main risk driver is disability/morbidity risk

• Index-linked and unit-linked life insurance contracts where the main risk driver is disability/morbidity risk.

• Other insurance contracts where the main risk driver is disability/morbidity risk.

• Annuities stemming from non-life contracts

• Health insurance which is not pursued on a similar technical basis to that of life insurance (Non-SLT Health) as follows:

– With regard to the line of business for annuities stemming from non-life contracts or health insurance includes only annuities stemming from Non-SLT health contracts (for example workers' compensation and income protection insurance). Insurance or reinsurance obligations that, although stemming from Non-Life or NSLT health insurance, and originally segmented into Non-Life or NSLT health lines of business, as a result of the trigger of an event are pursued on a similar technical basis to that of life insurance, should be assigned to the relevant life lines of business as soon as there is sufficient information to assess those obligations using life techniques. Allocated to one of the following:

• Medical expense

• Income protection

• Workers' compensation

197

Appendix 6: Reference Instrument and LLP

198

Appendix 7: Deferred Tax

• Undertakings should calculate the adjustment for deferred taxes in accordance with the Solvency II valuation principles and only for items recognized for SII purposes or for tax purposes in conformity with international accounting standards adopted by the Commission in accordance with Regulation (EC) No 1606/2002.

• Solvency II principles require the calculation of the adjustment by stressing the Solvency II balance sheet and determining the consequences on the undertaking’s tax figures. If undertakings do not set up a stressed SII balance sheet, a calculation with methods based on average tax rates can be considered appropriate as well, if such can be shown not to be a material misstatement of the adjustment.

• Undertakings shall value deferred taxes, other than deferred tax assets arising from the carryforward of unused tax credits and the carryforward of unused tax losses, on the basis of the difference between the values ascribed to assets and liabilities recognised and valued in accordance with Article 75 of Directive 2009/138/EC and in the case of technical provisions in accordance with Articles 76 to 85 of that Directive and the values ascribed to assets and liabilities as recognised and valued for tax purposes.

• Only ascribe a positive value to deferred tax assets where it is probable that future taxable profit will be available against which the deferred tax asset can be utilised, taking into account any legal or regulatory requirements on the time limits relating to the carryforward of unused tax losses or the carry-forward of unused tax credits. When assessing whether the undertaking has sufficient taxable profits to cover any net deferred tax assets the undertaking should assess the impact of the (national) tax regime on valuation and recognition of temporary differences.

• Undertakings should recognize notional deferred tax assets conditional on their temporary nature and based on the extent to which offsetting is permitted according to the relevant tax regimes, which may include offset against past tax liabilities, or current or likely future tax liabilities.

• Where an approach based on average tax rates is employed, undertakings should ensure that deferred tax liabilities in the unstressed Solvency II balance sheet are not double counted for the purpose of recognition.

• To avoid double counting, future profits for the recognition of deferred tax assets in the Solvency II balance sheet should be deducted from the post-stress projections of future profits. Only the remaining amount may be recognized to demonstrate eligibility of the notional deferred tax asset.

• Where the undertaking has entered into contractual agreements regarding the transfer of profit or loss to another undertaking or is bound by other arrangements under existing tax legislation in the member state, the undertaking’s calculation of the adjustment for loss-absorbing capacity of deferred taxes should take these agreements or arrangements into account. Where it is contractually agreed and probable that loss will be transferred to a third party (“receiving undertaking”) after the undertaking (“transferring undertaking”) suffers the instantaneous loss, the related deferred tax adjustment should not be recognized by the transferring undertaking except so far as payment or other benefit will be received in exchange for the transfer of notional tax losses.

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tthe endhe end ............ and an enjoyable Solvency II journey to you....................... and an enjoyable Solvency II journey to you...........