Solvency II A Work in Progress

1. Solvency IIA Work in Progress CAS Meeting, Quebec Alessa Quane June 2008

2. Soundbites “This is an ambitious proposal that will completely overhaul the way we ensure the financial soundness of our insurers.” – Charlie McCreevy, European Commissioner for Internal Market and Services “We are setting a world-leading standard that requires insurers to focus on managing all the risks they face and enables them to operate much more efficiently. It’s good news for consumers, for the insurance industry and the EU economy as a whole” - Charlie McCreevy, European Commissioner for Internal Market and Services “Solvency II is not just about capital. It is a change of behavior.” – Thomas Steffan, Chairman of CEIOPS “The purpose of Solvency II is not necessarily to strengthen the industry’s capital base, but more to ensure that sufficient regulatory and internal risk management controls are in place to enable management and regulators to more fully understand and control the dynamics of the industry’s risk profile.” – Simon Harris, Moody’s Team Managing Director for European Insurance.

3. What is Solvency II? • Updated set of insurance regulations for Europe facilitating the creation of a single market for insurance services in Europe while protecting consumers at a consistent level across all member states • Will introduce economic risk-based solvency requirements across all EU Member States • Total balance sheet approach versus only focusing on the liability side as Solvency I does • Emphasizes that capital is not the only way to mitigate against failures. Solvency II rules compel insurers specifically to focus on and devote significant resources to the identification, measurement and proactive management of risks. • Strengthen the role of the group supervisor • While Solvency II is a European initiative, many outside the EU are taking an interest in the development of the framework and its implementation.

4. Lamfalussy Process Source: CEA

5. European Union Parliament European Council of Ministers European Union Commission Committee of European Insurance and Occupational Pension Supervisors (CEIOPS) CEA (Comité Européen des Assurances) Groupe Consultatif Other stakeholders - CRO Forum, national regulators, individual firms both within the EEA and outside Solvency II Key Players

6. Solvency II Timetable 2010 2012 2009 2011 2007 2008 2006 2005 Full Implementation Directive Development Framework Directive Published Directive Adoption QIS 1 QIS 2 QIS 4 QIS 3 Further QIS * Initial discussions and drafting began prior to 2005.

7. Solvency II Timetable • 2008 is a crucial year in the timetable • Framework Directive defining the Level 1 principles for Solvency II will pass through the EU Parliament • Level 2 detailed implementing measures will be developed by the EU Commission • CEIOPS and other stakeholders will provide advice on the Level 2 measures • Individual firms will participate in QIS 4 and suggest wording for the Level 2 measures

8. Three Pillars of Solvency II Pillar I Pillar II Pillar III Surplus Surplus Assets Disclosure Requirements Assets Add-Ons SCR SCR MCR MCR Risk Margin Risk Margin Liabilities Liabilities Firm Analysis Supervisory Analysis

9. Solvency Capital Requirement Standard Formula Concentration

10. Financial Impact of New Regime • Solvency capital requirements will increase substantially for most European insurers, although the proposed regime does not require extra capital in the European insurance market as a whole. • No significant overall change in terms of the composition or size of the balance sheet compared with Solvency I at a European level • Technical provisions tend to decrease due to the implicit prudence in the current regime thereby increasing available capital • 98% of firms would find it unnecessary to raise additional capital to meet the MCR • 16% of insurers would need to raise additional funds to cover the SCR under QIS 3 • QIS 3 results indicate that non-life insurers appear to be more heavily impacted than life insurers

11. Composition of Non-Life SCR Source: CEIOPS’ Report on its Third Quantitative Impact Study for Solvency II

12. SCR Comparison with Internal Models • Internal models generally produce a higher charge for credit risk than the SCR module • For non-life insurance, internal models produce significantly lower total SCRs than the standard formula, with an average reduction of 25% • No clear pattern as to whether internal models produce a lower or higher operational risk charge than the standard formula Internal Model submissions in QIS 3 Represents 13% of firms, by submission numbers

13. Areas for Further Investigation • Non-EU supervisors and group proposals • Equivalence of regimes • Level playing field for EU and non-EU groups • Application of a consistenteconomic assessment of available and required capital to all businesses, both EEA and non-EEA • Technical Provisions • More guidance on calculation of the risk margin • Is the 6% cost of capital still a placeholder? • Diversification between lines of business • Debate around possible simplifications or proxies to make up for a lack of data • Recognition of future premium

14. Areas for Further Work • SCR • Calibration of non-life underwriting risk • Granularity of equity risk shocks • Treatment of unrated entities with regard to counterparty default risk • Possible simplification of the concentration risk component and impact on firms in smaller countries with fewer market options • Inclusion of expected profits • Exclusion of free assets in the market risk module • Appropriate treatment of catastrophes • Structure and calibration of the MCR • Ladder of intervention • Consistent framework • Compact Approach • Modular Approach • Linear Approach

15. Areas for Further Work • Own Funds • Guidance on classification of eligible elements • Implications for hybrid instruments • Clarification on valuation of participations (look-through vs market value) • Groups • Non-comparable data has been supplied and clarification is therefore needed in order to draw conclusions on these issues • Scope of consolidation • Group coverage • Internal model results • Consideration of the rules to which cross sector and non-EEA entities are subject as well as the extent to which surplus assets are transferable

16. Areas for Further Work • Internal Models • Criteria for model approval • Statistical quality • Use test • Documentation standards

17. Implications for Firms • Require more formal approach to governance demonstrating that insurers are aware of the risks affecting their business and that they have embedded this awareness in the daily running of the business. • Cost of compliance is likely to be significant and will be a large change for many jurisdictions. • Possible consolidation within the insurance industry as small firms may be disadvantaged by lack of technical resources, lack of geographic and product diversification and more expensive capital • Move toward risk sensitive pricing as a result of more efficient capital allocation. This will lead to greater segmentation and value driven products. • Increase demand for reinsurance, liability securitization and hedging • Further fuel the rating agencies shift in focus onto companies’ risk management frameworks and desire for disclosure.

18. Implications for Actuaries • Require more complex analysis and systematic approaches to risk management. This will increase the demand for actuaries and risk management personnel. • Need to more closely coordinate with finance, risk management and other business functions. • Better explanation of assumptions, sensitivities, limitations and methods underlying the computations and results to senior management who will be relying on this information throughout the risk embedding process. • Increase in the development of advanced analytical tools and systems capable of providing a more informed basis for control and decision-making.