SOLVENCY II Level 2 Implementing Measures Position after the 3 waves of Consultation Papers and the Quantitative Impact Study 5 Technical Specifications Dr. Thomas Guidon CASUALTY LOSS RESERVE SEMINAR 21 September 2010 Intl – 2: Solvency II – Update and Current Events Status Quo Solvency II Level 2 implementing measures § The European Commission asked CEIOPS to launch a consultation process with the (re)insurance industry players Three waves of Consultation Papers (CPs) q 1. wave of 12 CP’s published on 26 th March 2009. � 2. wave of 24 CPs published on 2 nd July 2009. � 3. wave of 17 CP’s published on the 2 nd November 2009. � q The outcomes from these consultations assisted CEIOPS in issuing final advices to the European Commission. § The following diagram shows the main topics addressed in the Level 2 implementation measures, organised by theme, with the topics addressed in the 1 st , 2 nd and 3 rd waves of CPs illustrated in orange, blue and red respectively. Solv ency II - Position af ter the 3 wav es of CPs and QIS 5 3 1
Legend Overview of the main topics addressed in the level 2 Topics addressed in the 1 st wave implementation measures of CPs published in March 09 Pillar III Supervisory Disclosure (CP58) Reporting Transparency and Accountability (CP34) Topics (CP58) addressed in the 2 nd wave of CPs published in Pillar II July 09 Internal Model Economic Balance Sheet Capital Tests and Standards for Internal Group Supervision Approval by the Topics (CP66) add-on Regulator (CP37) Model Approval (CP56) Approv al of ancillary own f unds (CP29) addressed in (CP57) the 3 rd wave Classif ication and eligibility of own f unds (CP46) of CPs published in Pillar I N Novem ber 09 Valuation of Assets and Treatment of ring-f enced “other” Liabilities (CP35) f unds (CP68) Internal Model Treatment of Participations (CP67) Partial Internal Model (CP65) Group Internal Model (CP37 Addendum) G O V Data and Technical Characteristics of the Model E Assumptions R N SCR Solo SCR Group Technical Provisions A Standards f or SCR Group Data Quality N SCR SCR Treatment of Future (CP60) Market Risk Operational (CP43) C Premiums (CP30) Methods and statistical (CP47) Risk (CP53) Risk E techniques for calculating Concentration the Best Estimate SCR Counterparty Def ault M Undertaking (CP61) Assumptions about future (CP26/39) Risk (CP28) Specif ic ( CP33 ) management actions Intra-Group C Parameters (CP32) Transactions (CP75) Simplif ications Risk Margin SCR Underwriting Risk Lif e / R non-Lif e / Health (CP48-50) (CP61) (CP45) (CP42) Risk-Free Interest Rate Group Solv ency (CP40) Counterparty Calculation Loss Absorbing Capacity of TP Assessment (CP73) Correlation Def ault of TP as a (CP54) (CP60) Parameters Segmentation between Adjustment whole (CP74) (CP44) (CP41) Non-EU lines of business (CP27) Allowance of Financial Mitigation subsidiaries Techniques (CP31) (CP60) Solv ency II - Position af ter the 3 wav es of CPs and QIS 5 4 Economic Balance Sheet CP 26 – Technical Provisions – Methods and Techniques for calculating the Best Estimate CP27 – Segmentation CP30 – Treatment of Future Premiums CP35 – Valuation of Assets and “other Liabilities” CP39 – Technical Provisions – Actuarial and statistical methodologies to calculate the Best Estimate (BE) CP42 – Calculation of the Risk Margin CP46 – Classification and eligibility of own funds QIS5 –Technical Specifications Solv ency II - Position af ter the 3 wav es of CPs and QIS 5 5 Economic Balance Sheet Main Principles to Remember § The methods of valuation of the different components of the balance IFRS Standards Solv ency II sheet are based on two important principles: q Convergence of the regulatory environment: SII Economic MCEV Balance Sheet is defined according to the IFRS principles. This approach should � Lead to cost & resource synergies of between SII and IFRS Solvency II Balance Sheet � Ease financial communications as reporting is on a consistent basis. Net Assets S2 Net = Assets (A) – (B) S2 – Deferred Predominance of the Balance Sheet approach: Valuation q Taxes Deferred Taxes principles for assets and liabilities lead to Market Other Liabilities Value of Assets � Own funds are the balance between the valuation of assets and liabilities Risk (A) Margin � Recognition of future profit/loss generated by existing contracts and reserve Discounted Best Liabilities strengthening/redundancies Estimate (B) Insurance � Future cash-flows generated by the assets are split between Liabilities • the policyholders (Best Estimate and Risk Margin), • taxes (Deferred taxes) and • profit allocated to shareholders. Shareholder’s Equities + PVL Unallocated Assets � Therefore the economic valuation leads to the consideration of future profits Net Future Margins within the net assets. Goodwill - � SII’s balance sheet approach is expected to lead to new KPIs within the Other industry. Solv ency II - Position af ter the 3 wav es of CPs and QIS 5 6 2
Economic Balance Sheet Technical Provisions Valuation of non-life insurance liabilities on a market-consistent basis: § Technical Provisions are on a Marking-to-Model bases as insurance liabilities are illiquid. § Marking-to-Model is based on future cash-flows: Cash-flows should be estimated gross of amounts recoverable from reinsurance contracts q Cash-flows should account for the full lifetime of existing insurance contracts and reflect policyholder q behaviour and management actions Companies need to consider all inflows (e.g. premiums and receivables) and outflows (i.e. claims q payments, expenses ...) Cash-flows for premiums provision and outstanding claims need to be estimated separately q § Marking-to-Model needs to consider: replace unearned premiums reserve by premiums provision. Premiums provision corresponds to the q present value of future cash inflows and outflows related to the unexpired risk. Consequence: expected future profits or losses on unexpired risk are recognised in the economic balance sheet. tacit renewals which have already taken place at the valuation date should be included in the calculation q of the best estimate of the premiums provision. expenses (allocated and unallocated) will be included in projected future cash-flows. q Reinsurance recoverable is shown as asset. The valuation should follow the same principles as the q gross claims provisions. Recoverable are exposed to counterparty default risk and do not require any risk margin. Solv ency II - Position af ter the 3 wav es of CPs and QIS 5 7 Economic Balance Sheet Technical Provisions § The choice of discount rate: Risk free interest rate term structure (based on government bonds) vs. credit swap rates. q QIS4 and CP40 favoured use of government bonds and QIS5 is based on credit swap rates. q § The rate term structure will include a 50% illiquidity premium in QIS5 for non-life liabilities. This is new compared to QIS4 and contrary to the final advice of CP40. q § Risk margin is based on cost of capital approach with a rate of at least 6%. Risk Margin calculation is on undertaking level in QIS5, hence enjoys diversification benefit (contrary to q QIS4 and final advice of CP42) The risk margin is calculated as follows: Future SCR Run-Off of the SCR for Underwriting, Counterparty and Operational Risks SCR( 0) SCR( 1) ∑ SCR ( t ) = × CoC 6 % ( ) + t SCR( 2) 0 1 r > SCR( 3) t t SCR( t) … t = 0 t = 1 t = 2 t = 3 t Discounting using the risk-free rate term structure Solv ency II - Position af ter the 3 wav es of CPs and QIS 5 8 Economic Balance Sheet Technical Provisions - Methodology Collection & analy sis of data Segmentation is part of the Assumptions must be process. consistent both with: Determination of Documentation assumptions • Financial market data • “Generally av ailable” insurance risk data. Methodology Must be documented, justif ied and v alidated Modelling, parameterisation Controls and quantif ication Expert rev iew of estimation CEIOPS has kept the QIS4 approach for segmentation: 14 segments (including « Worker’s compensation ») in Non-Life (Re)Insurance Non-Life Insurance and Non-Life Non-Proportional § 14 risk classes for Non-Life (Re)insurance and Proportional Reinsurance Reinsurance Worker’s compensation Casualty § a double segmentation in Life (Re)insurance with 16 classes. A ccident and Health Property Motor Vehicle Liability Marine, aviation, transport A policy covering several risks needs to be split into different q Motor other classes segments. Marine, aviation, transport Fire and other damages to Property § Pillar 3: CEIOPS might ask economic capital to be split Third-Party Liability Credit and Surety according to the same segmentation. Legal Expenses A ssistance Miscellaneous Solv ency II - Position af ter the 3 wav es of CPs and QIS 5 9 3
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