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Solvency II and the Swiss Solvency Test. János Blum. Casualty Loss Reserve Seminar San Diego, 11 September 2007. Contents. Swiss Solvency Test Industry Engagement -Test Runs. Swiss Solvency Test. Swiss Solvency Test.
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Solvency II and the Swiss Solvency Test János Blum Casualty Loss Reserve Seminar San Diego, 11 September 2007
Contents • Swiss Solvency Test • Industry Engagement -Test Runs
Swiss Solvency Test • Switzerland is not member of the European Union, but Swiss companies have pivotal interest in EU regulation • Compatibility to EU is a main objective of SST • Swiss Federal Office of Private Insurance designed, tested and partially implemented the new solvency system between 2002 and 2006 • New Insurance Supervisory Law effective since 2006 • Full implementation of SST beginning 2011
Old Insurance Supervision • Rule based • Product and Tariff Approval • Restrictions on products, investments and pricing • No consideration of asset risks
Old Insurance Supervision - Problems • Overexposure to risky assets • Underpriced longterm guarantees • Accounting and regulatory arbitrage • Compliance culture • Abrogation of responsibility to the regulator
New Insurance SupervisionAct of 1.1.2006 • No restrictions on products (except for some mandatory life and health products) • Less restrictions on investments • Corporate governance and risk management requirements • Appointed Actuary for all insurers and reinsurers
New Insurance Supervision Act of 1.1.2006 • Supervision of groups and conglomerates • Consistent requirements for insurers and reinsurers • Responsibility with senior management • Principle based
The SST PrinciplesOutput – Methodology – Transparency - Responsibility • 8. Scenarios defined by the regulator as well as company specific scenarios have to be evaluated and, if relevant, aggregated within the target capital calculation • 9. All relevant probabilistic states have to be modeled probabilistically • Partial and full internal models can and should be used. If the SST standard model is not applicable, then a partial or full internal model has to be used • The internal model has to be integrated into the core processes within the company • SST Report to supervisor such that a knowledgeable 3rd party can understand the results • Public disclosure of methodology of internal model such that a knowledgeable 3rd party can get a reasonably good impression on methodology and design decisions • Senior Management is responsible for the adherence to principles • All assets and liabilities are valued market consistently • Risks considered are market, credit and insurance risks • Risk-bearing capital is defined as the difference of the market consistent value of assets less the market consistent value of liabilities, plus the market value margin • Target capital is defined as the sum of the Expected Shortfall of change of risk-bearing capital within one year at the 99% confidence level plus the market value margin • The market value margin is approximated by the cost of the present value of future required regulatory capital for the run-off of the portfolio of assets and liabilities • Under the SST, an insurer’s capital adequacy is defined if its target capital is less than its risk bearing capital • The scope of the SST is legal entity and group / conglomerate level domiciled in Switzerland
Some Differences SST – Solvency II • 99% TVar vs. 99.5% Var confidence level • Cost of Capital approach for Market Value Margin • EU has not yet decided between i) 75th percentile and ii) Cost of Capital approach • Minimum Capital Requirement 60% of Solvency Capital Requirement • EU has not yet decided between i) percentage of SCR and ii) separate calculation for MCR, i.e. 90% confidence level • Operational Risk taken into account, but not part of Pillar I, as not sufficiently quantifiable • No restrictions on eligibility of capital – no tiers
Cost of Capital Approach • SCR absorbs risks with 1 year time horizon • At the end of year 1, portfolio is assumed to be taken over by another company • New company provides regulatory capital to absorb run-off risk • Market Value Margin is the NPV of the future cost of capital at risk free rate + 6%
Internal Models • If standard model not applicable, internal models mandatory • reinsurance, groups, entities with foreign branches • estimated 80 entities will have to develop internal models • Internal models encouraged, as they demonstrate high risk management skills and provide relevant company specific information • High technical standards: stochastic modelling required. Building and validating internal models is resource intensive. • Consistency: same model should be used for all external reporting (regulator, rating agencies) and internal steering purposes
Groups • Incentive to simplify complex group structures • SST required both on entity level and group level • Detailed internal model for groups • Diversification benefit on group level • Explicit modeling of Capital and Risk Transfer Instruments • internal reinsurance • loans • participations • guarantees • capital mobility
Small Companies • Increased consolidation pressure • Complexity of Solvency II is a challenge for small entities: • limited availability of resources and data • low participation in test runs indicates lack of awareness • loss mitigation relatively expensive • standard model leads to high capital requirements, building more favourable internal models not viable
Risk Management & Risk Mitigation • Risk Management will become key competence • Data quality • Capital adjusted pricing and product structuring • Modelling capabilities • Demand for Risk Mitigation will increase • Hedging financial risk for life insurers • Reinsuring or securitizing cat risk for P&C insurers
Quantitative Impact Studies • 2005: QIS 1 • compared reserves under Solvency I and Solvency II • measured existing levels of prudence • tested Cost of Capital approach • increased awareness in the insurance industry • 2006: QIS 2 • tested methods for calculating provisions, asset values, SCR and MCR • gathered information on practicability, data issues and resource requirements • measured changes of overall level of solvency ratio • 2007: QIS 3 • calibrates risk and correlation matrices • tests impact on groups • tests internal vs standard models • results to be published in fall 2007 • 2008: possibly QIS 4 to back test draft directives
Quantitative Impact Study 2 • 514 companies (out of 4‘000) from 23 countries participated • 237 P&C, 161 Life, 81 Composite, 22 Health, 13 Reinsurance • Overall market share 65% for Life, 56% for P&C • vary from 11% to 94% from country to country • Generally lower participation by small companies • Data quality inhomogeneous • Results published on a no name basis
QIS 2 – Impact on Solvency • Assets valuated higher • Liabilities valuated lower • > Resulting Available Capital higher • Required Capital much higher • > Solvency Ratios decrease in general • Most Companies still with Solvency Ratios > 100%
Swiss Field Tests • Facultative in 2004 and 2005 (before new legislation) • Mandatory for large companies in 2006 and 2007 • 46 (out of 150) entities participated in 2006, 29 of them on a voluntary basis. >90% market share covered. • Mandatory reporting for all companies starting 2008 • Intervention based on new regime starting 2011, i.e. three year transition period
SST - Solvency Ratios • Solvency Ratios lower, but mostly still sufficient (similar to QIS results) • Life: low correlation between old and new Solvency Ratios (R2 = 12%) • P&C: no correlation between old and new Solvency Ratios (R2< 1%) • i.e. completely new situation for most companies
Key findings • Life insurers sufficiently, P&C insurers well capitalized • Assets main risk for life insurers, balance sheets vulnerable to historic economic scenarios • Insurance (underwriting incl. cat) main risk for P&C insurers, balance sheets resistant to scenarios • Market Value Margin (reserve risk beyond 1 year) almost negligible for P&C insurers, more important for life companies
