Solvency II Conference Two years on and two reviews 1
Presentation Olav Jones Deputy director general Insurance Europe
Agenda 1 Successful launch 2 Impact survey 3 Concerns about excessive capital 4 Case studies 5 Solvency II reviews 3
A long journey … 2000 Solvency II 2007 project Proposal by 2009 Commission After extensive negotiations, agreed by EC, EP, Council 2010 to be applied October 2012 QIS 5 revealed need for essential 2011 corrections 2013 EC taskforce with EIOPA & industry LTGA to fix to work on treatment of long- solutions term business & 2013 – 2014 liabilities valuation Final political (Omnibus II) agreement in January November 2013 2016 Finalisation of implementation rules Application
A long journey … and it is not over yet Application of Solvency II (January 2016) Infrastructure (April 2016) STS securitisations (June 2016) 2018 review (Level 2) (December 2018) EC fitness check on supervisory reporting 2020 review (December 2019) (Levels 1+2) (December 2020) 5
Huge implementation challenge Revolution not evolution 3000 companies with €10trn of assets Sophisticated modelling required even for standard formula users 184 reporting templates 3500+ pages of requirements 6
Successful implementation was not by chance Industry already: very strongly capitalised with risk management as core focus with widespread development of ERM & economic capital concepts Significant preparation over many years: helped by many QISs very significant efforts by industry, national supervisors & EIOPA huge investment 7
World-class framework Three pillars Group & solo measures Economic valuation of assets & liabilities Best estimates of liabilities All risks (28 in standard formula) Most risks use scenario (stress test) approach Internal models allowed Two levels of capital (SCR & MCR) allowing early supervisory intervention Strong & clear target level of protection: 99.5% Significant testing & transitional measures 8
Some improvements still needed Specific technical issues/ calibrations Proportionality Treatment of long-term business
Agenda 1 Successful launch 2 Impact survey 3 Concerns about excessive capital 4 Case studies 5 Solvency II reviews 10
Positive impacts Risk management/governance Data quality ALM Harmonisation Internal models Any other benefits 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% % of respondents reporting improvements due to Solvency II 11
Unintended consequences 48% 58% “We invested less than “SII contributed to negative optimally in real economy due impact on guarantee to SII capital requirements” business” 12
Unintended consequences “The current offer of “Increased SII guaranteed capital requirements would products will not be make investment sustainable … strategic strategies for “We have prioritised plan envisages the clients too the sales of unit- gradual decline in the conservative if they linked business with supply of guaranteed have guarantees” low capital products with the requirements growth of unit-linked compared to other products” guaranteed products” “SII has led to a stronger focus on capital light products” 13
Agenda 1 Successful launch 2 Impact survey 3 Concerns about excessive capital 4 Case studies 5 Solvency II reviews 14
Unnecessarily high capital = unnecessary impact and/or and/or Too high Less optimal Higher Lower solvency capital long-term premiums benefits paid investment or e.g. equities charges Procyclical Fewer products behaviour available 15
Three causes 1. Liabilities exaggerated Regulatory Technical provisions (Amount needed to cover payment of claims and other liabilities) Illustrative 16 not to scale
Three causes 1. Liabilities exaggerated Discounting close to risk free • Risk Margin • Amount needed to cover payment of claims and other liabilities Illustrative 17 not to scale
Three causes Company surplus 3. Artificial volatility Larger buffers than necessary • Company target Solvency buffer 2. Excessive SCR requirements Regulatory Solvency Wrongly based on “trading risk” Capital • instead of “long -term investment Requirement risk” (SCR) Total amount needed by SII can be 1. Liabilities exaggerated Regulatory excessive Risk Margin • Technical provisions Discounting close to risk free • (Amount needed to cover payment of claims and other liabilities) Illustrative 18 not to scale
Agenda 1 Successful launch 2 Impact survey 3 Concerns about excessive capital 4 Case studies 5 Solvency II reviews 19
Long- term investment ≠ trading Long- term risk ≠ trading 20
Importance of measuring risk correctly 1-in-200 Equity example outcome Trader can be forced to sell entire portfolio after worst-case, -43% 1 1-year price fall 2 -26% Insurer can invest for 10 years and get dividends Insurer can invest for 10 years, get dividends and use 3 +9% pooling/smoothing, diversifying across customers/time Analysis based on 100 years of US stock market data 21
Excessive capital requirements CASE STUDY Simple, long-term product with guarantee €10,000 single premium Fully matched (no interest rate risk) Standard Formula and Volatility Adjustment Only invested in A-rated corporate bonds Risk Margin = 40% of SCR in line with EU average for life companies 22
Preliminary analysis Total additional amount shareholders need to inject 40% 35% 30% Volatility buffer 25% Solvency capital requirement (SCR) 20% Risk Margin 15% Discounting close to risk free 10% 5% 0% 1 Risk-free rate is 0.50% 1 Guaranteed product Credit spread is 1.25% Volatility adjustment is 0.04% (Dec. 2017) Charges are 0.50%
Preliminary analysis Total additional amount shareholders need to inject 40% 35% 30% Volatility buffer 25% Solvency capital 20% requirement (SCR) ? Risk Margin 15% Discounting close to risk 10% free 5% 1 Risk-free rate is 0.50% Credit spread is 1.25% 0% 1 Volatility adjustment is 0.04% Guaranteed product Guaranteed product Correct capital (Dec. 2017) (Solvency I) requirements Charges are 0.50%
Solvency II = shifting the risks on to individuals RISK INSURANCE COMPANY 25
Further work needed Industry, academics, supervisors and regulators need to work together to fully understand different measures & their impact Examine improvements: VA/MA/dynamic VA/Country adjustments Risk Margin SCR for investments Test against different products & market conditions 26
Agenda 1 Successful launch 2 Impact survey 3 Concerns about excessive capital 4 Case studies 5 Solvency II reviews 27
A long journey … and it is not over yet Application of Solvency II (January 2016) Infrastructure (April 2016) STS securitisations (June 2016) 2018 review (Level 2) (December 2018) EC fitness check on supervisory reporting 2020 review (December 2019) (Levels 1+2) (December 2020) 28
EC action can make a difference Long-term equity 43% Infrastructure 43% Unrated debt 36% Unlisted equity 29% STS securitisation 16% ELTIFs 3% 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% % of respondents who said EC action has had/would have positive 29 impact on investment
On the path to improvement SOLUTIONS PROBLEMS Capital Markets Union 2018 review 2020 review Infrastructure Equity (unlisted and Other long-term listed ) investments STS securitisations Solvency II doesn’t Unrated debt reflect long-term Risk Margin — cost of Risk Margin business capital Discount rates (MA, VA, etc.) Simplifications Streamlining Proportionality/ reporting Address flaws/ Address flaws/ Other technical issues inconsistencies inconsistencies 30
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