the macro picture of market consolidation and the ... · as the volatility is assessed over the net...
TRANSCRIPT
The Macro Picture of Market Consolidation and the influence of Prudential Regulation
Ernst & Young’s Annual Global Insurance Conference The Changing Landscape
03 June 2008
1
Alberto Corinti – CEA Deputy Director General
Outline
Relationship between consolidation and prudential regulationUnder Solvency IUnder the forthcoming Solvency II
Financial requirementsOrganizational aspectsGroup supervision
How can Solvency II be neutral?
2
Market evidenceMarket evidence
Number of companies in Europe
Relation premium income and marketshare of the TOP 5 in non-life insurance
Relation premium income and marketshare of the TOP 5 in life insurance
Cumulated market share of the 20 largerEuropean group of insurance
Average of the market share of the largest groups on the national market
Company size
Outline
Market evidence
Under the forthcoming Solvency IIFinancial requirementsOrganizational aspectsGroup supervision
How can Solvency II be neutral?
9
Relationship between consolidation and prudential regulationRelationship between consolidation and prudential regulationUnder Solvency IUnder Solvency I
Consolidation and Solvency I
Consolidation is already apparent in the market
It is unlikely that Solvency I regulation has been a driving factor:
No risk based supervision (capital requirement predominantly dependent on the size)No recognition of risk mitigationNo incentive for efficiency of internal managementNo recognition of economic reality of groups
Will Solvency II enhance or slow down the market trend?
Outline
The market evidence
Relationship between consolidation and prudential regulationRelationship between consolidation and prudential regulationUnder Solvency I
Organizational aspectsGroup supervision
How can Solvency II be neutral?
11
Under the forthcoming Solvency IIUnder the forthcoming Solvency IIFinancial requirementsFinancial requirements
Consolidation and Solvency II Financial requirements
The new regime is designed to capture and measure the specific risk profile of the company in terms of capital requirements
Being based on an economic approach, the new regulation is going to reward well diversified companies
To the extent that the size will positively affect the risk profile (e.g. by limiting volatility), and assuming that diversificationincreases with the increase of the size, one could conclude thatSolvency II will favour the current consolidation trend
Source: CEIOPS 13
SCR
Basic SCROperational
risk
HealthNon-Life Market Default Life
Premium reserve
Catastrophe
Interest rate
Property
Currency Mortality
Longevity
Revision
Lapse
Expense
Disability
Claims
Expense
Epidemic
Spread
EquityConcen-tration
Catastrophe
Factor based
Scenario based
Adjustment forRisk-mitigating effect of future profit-sharing
Correlation
Example - The SCR Standard Approach
Market Default Life Health Non-life
Market 1 - - - -
Default 0.25 1 - - -
Life 0.25 0.25 1 - -
Health 0.25 0.25 0.25 1 -
Non-life 0.25 0.5 0 0.25 1
Aggregation of capital charges using correlation matrix.
Example - Calculation of Basic SCR in QIS 4Recognition of diversification between risk modules
14
Consolidation and Solvency IIFinancial requirements
However, small companies could also be well diversified
Reinsurance and other risk mitigation mechanisms are a way for buying diversification
The quality of the portfolio in terms of risk is not necessarily connected only to the size. Small companies could have advantages related to a better knowledge of their policyholders (in particular for niche market), to a better selection, to a more efficient management of insurance process
Calculation of capital requirements in Solvency II are not always influenced by the size. In some cases (when using a scenario approach) the formula capture the risk profile independently of the size
Example 1 – premium & reserve risk charge for a non-life company
33%
28%
27%
% of premiumvolume
1 Geography
3 Geographies
10 Geographies
Multi line10 LOBs
Multi line5 LOBs
43%
36%
33%
16
According to QIS4, standard factors are applied to the premiums and reserves to obtain a charge for premium & reserve riskThe table below shows the capital requirements, for some non-life companies
Companies can use company-specific data to derive their own factorsOne would expect, gross of reinsurance, that larger companies will have more stable portfolios and can therefore benefit via lower company specific factors
As the volatility is assessed over the net portfolio, smaller companies can reduce their volatility by purchasing reinsurance and can therefore also benefit from lower factors
Example 2 – life underwriting risk
Mortalityn Permanent increase of 10% in mortality ratesn For contracts where death SA > TP
Longevityn Permanent decrease of 25% in mortality ratesn For contracts where death SA < TP
Disabilityn Increase of 35% in disability rates for next year with
permanent increase of 25% in following years
Expense n Increase in expenses of 10%, plus 1% increase in
inflation
Catastrophen Formula based on 0.15% of capital at risk for mortality
and disability riskn No mass lapse risk on linked business
17
The stresses applied in QIS4 for life risk are provided below:
18
Example 2 – life underwriting risk (cont’)
According to QIS4, the stresses are all defined by the specifications and are the same for all companies, regardless of the size
Hence, according to the standard approach, we do not expect differences in requirements due to the size of the company
When a company applies an internal model, it could potentially benefit from lower stresses, assuming the portfolio is stable
Portfolios are likely to be more stable for larger companies opposed to smaller companies, but…… smaller companies can reduce the inherent volatility by purchasing additional reinsurance
Outline
The market evidence
Relationship between consolidation and prudential regulationRelationship between consolidation and prudential regulationUnder Solvency I
Under the forthcoming Solvency IIUnder the forthcoming Solvency IIFinancial requirements
Group supervision
How can Solvency II be neutral?
19
Organizational aspectsOrganizational aspects
Consolidation and Solvency IIOrganizational aspects
Solvency II (Pillar II) will require appropriate governance, risk management system, internal control functions, etc…
In addition, it allows companies to use (after supervisory approval) their internal model in order to determine their capital requirement
This could entail important investments. Purchase of high professional expertise will become more important. Dimension and achievement of economy of scale could be critical in this regard. Therefore, in this case also, Solvency II would in principle foster consolidation
However, adequate application of the principle of proportionality should avoid that these requirements turn out to be too burdensome for SMEs (provided that small size is also small risk)
Also, outsourcing could represent an efficient solution for SMEs
Evidence from a CEA survey(Solvency II Impact Assessment)
This applies to all companies - large, medium and small
Most companies are already developing risk management frameworks …
Evidence from a CEA survey(cont’)
Solvency II therefore provides a great opportunity to align regulatory requirements with industry best practice risk management
Regulatory change is not the only driver for improved risk management
Outline
The market evidence
Relationship between consolidation and prudential regulationRelationship between consolidation and prudential regulationUnder Solvency I
Under the forthcoming Solvency IIUnder the forthcoming Solvency IIFinancial requirementsOrganizational aspects
How can Solvency II be neutral?
23
Group supervisionGroup supervision
Consolidation and Group Supervision
Solvency II will introduce a supervisory regime for groups at an equal footing with solo supervision. Supervisory tools (solvency, riskconcentration and intra-group transactions, governance) will be applied at group level as well
In terms of capital requirements, Solvency II risk based approach should be applied to the group as a whole, recognizing its economic reality
Group SCR represents the economic capital the group has to hold in order to absorb significant unforeseen losses over a 1-year time horizon measured on the basis of a 99.5% Level of Confidence (Same requirement applies to stand-alone undertakings)
In view of potential group diversification benefits, in an economic risk based environment, group SCR must be lower than the ∑ solo SCRs
Solvency II proposes the “group support regime” as a way to recognize diversification benefits at group level
24
Example - Group without recognition for group diversification effects
Solo A Solo B Solo C Group
SCR
MCR
SCR
MCR
SCR
MCR
MCR
∑ solo SCRs
Group without group support has no/little means to downstream group diversification effects. As a result, it would have to hold sufficient capital to meet ∑solo SCRs which is in excess of the Group SCR.
= own fundsKey:
Group SCR
Note: for illustrative purposes only
In practice: minimum capital level for the group
25
Example - Group with recognition for group diversification effects
Solo A Solo B Solo C Group
SCR
MCR
SCR
MCR
SCR
MCR
Group SCR
MCR
∑ solo SCRsDiversification benefits= own funds
= Declaration of group support
Key:
Note: for illustrative purposes only
No change to solo SCRs
26
Group support allows for: 1.Efficient capital allocation 2.Recognition of diversification effects (difference between ∑ solo SCRs and Group SCR)
Consolidation and Group Supervision
Group support is a practical and transparent instrument to allocate capital in the most efficient way and allows the group to benefit from the recognition of diversifications effects
Allows to apply the same confidence level for the capital requirement of a group as for stand-alone entities (99.5% confidence level)
It ensures neutrality with regard to the option branch vs. groupstructure
The proposal of the EU COM is strongly supported by the industrybut is still the object of a significant debate
27
Outline
The market evidence
Relationship between consolidation and prudential regulationUnder Solvency IUnder the forthcoming Solvency II
Financial requirementsOrganizational aspectsGroup supervision
28
How can Solvency II be neutral ?How can Solvency II be neutral ?
How can Solvency II be neutral?
Provided Solvency II is designed appropriately, it is not expected to unduly affect market trends
Essential elements to achieve this are:Full recognition of risk mitigation mechanismsUse of entity specific data for calculating the standard SCRUse of internal models (also partial)Adequate application of the principle of proportionalityAppropriate supervision of outsourced activitiesRecognition of diversification effects at group level
Conclusions
In conclusion, Solvency II, if designed as expected, will fosterconsolidation only to the extent that underlying economic forces do
Well managed SMEs can and should continue to cover an important role in the EU market. They can even reinforce their market position by focussing on non scalable functions
Regulation should not unduly interfere with sound market developments
Alignment between compliance to regulation and best practices will benefit all parties involved, including policyholders
