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Solvency II – Newsletter

No. 7/en. October 2006

The European Commission is systematically pursuing its approach for implementing a new Directive. A first draft Framework Directive is expected within the next few months. Preparing for new requirements is a topic that is occupying not only the Commission and the supervisory authorities but also insurance companies themselves. The large number of European insurers taking part in the quantitative impact studies – by no means only global players – indicates the insurance industry's enormous interest in a fundamental reform of financial supervision.

Current developments
European Commission Publication of a Framework Directive Solvency II impact assessment Based on the current position of discussions, the first draft for a Framework Directive is due to be published at the beginning of January 2007. A first official proposal is expected for summer 2007. As well as working on the proposal for a Directive, the European Commission is preparing a report showing the potential impact of the new solvency rules and providing a cost-benefit analysis. The requirement for a comprehensive overall assessment – whose final version is expected in February 2007 – in which the legislation is also considered in terms of economic effects and potential costs, was already on the agenda at the beginning of the year. Of decisive importance in this context are investigations of the following points:

§ § §

Economic implications of Solvency II and effects on the financial stability of the markets. The task of investigating has been assumed by the European Central Bank, chiefly because of its closeness to the capital markets. Impacts on insurance companies and supervisory authorities. This assessment is being covered by a CEIOPS report in connection with the 1 results of QIS2 . Effects on insurance products and markets. This assessment has been 2 carried out in a separate study by the European Insurance and 3 Reinsurance Federation (CEA ).

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Quantitative impact study, cf. subitem "Quantitative impact studies – QIS2". Impact assessment study, cf. subitem "CEA". Comité Européen des Assurances.

solvency II newsletter no.7.doc (6 Seiten,

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Public hearing

On 21 June 2006, the EU Commission held a public hearing in Brussels. This focused on the impacts insurers expect from Solvency II for themselves and their clients and about possible influences on insurance products and markets. The demand for supervisory authorities to introduce clear criteria for evaluating solvency is seen as an important step to increasing transparency for all involved, not least in policyholders' interests. In addition, the call was made for an extensive discussion of supervisory processes (pillar 2). In particular, this involves control instruments for § § § investment and risk management, harmonisation of supervisory powers, company’s internal capital and risk assessment.

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Another topic of the discussion was the clarification on how the balance sheet for the supervisory authorities is to be prepared in future. It is unclear, for example, how the Commission intends to ensure further progress in the future measurement of balance sheet items. Of particular relevance are the technical provisions, which comprise an estimate of future cash flows for losses already incurred ("best estimate") and a risk margin. With reference to the QIS2 results, the debate about the method for determining the best estimate appears to be of fundamental importance. CEIOPS CEIOPS publishes sixth progress report CEIOPS is vigorously pursuing the objective of supporting the European Commission in all questions relating to the different process stages. In the coming months, CEIOPS will be focusing particularly on the publication of a first draft by the European Commission for a Framework Directive, the EU's aim being to publish a first proposal for a Directive in the summer of 2007. In addition to this, a great deal of work will be necessary in connection with implementing the Directive. The responses to the first waves of calls for advice have already been 5 published. These papers represent a major step towards harmonisation of the European solvency system. However, there is still a need for discussion on some points. Not all the proposals made by CEIOPS have been discussed in the necessary detail. The European Commission announced back in January 2006 that further consultation papers would follow. These are to centre on the following topics: § § § § § § § § § Development of a standard formula for calculating the SCR Development of a formula for calculating the MCR Identification of interfaces between accounting and solvency, especially in valuation of technical provisions. Recognition of reinsurance Additional capital requirements ("capital add-ons") Capital allocation within an insurance group, and the extent to which diversification effects and fungibility of capital should be considered Issues regarding the supervision of subsidiaries whose parent companies are located outside Europe Cooperation with third countries Incorporation of whole insurance groups in further QISs

Consultation papers

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Cf. http://ec.europa.eu/internal_market/insurance/solvency2/hearing_en.htm. Cf. http://www.ceiops.org/content/view/17/21/.

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CEIOPS publishes two further consultation papers, CP 13 and 14

The first two consultation papers in this connection, Nos. 13 and 14, were 6 presented this July. In Consultation Paper No. 13, CEIOPS proposes that insurance companies should be required to introduce additional internal instruments for risk capital management (Internal Risk Capital Assessment – IRCA). Companies should have in place internal control mechanisms and processes that allow quantitative and qualitative measurement of each risk identified. In addition, the paper shows acceptance emerging for the introduction of additional capital requirements in connection with the second pillar ("Pillar II capital add-ons"). However, in CEIOPS' view, these should only be required in exceptional cases, such as when business strategies or internal processes are unclear. Besides this, in Consultation Paper No. 14, CEIOPS agrees with the European Commission that diversification effects should be recognised. To what extent this should happen has not been methodologically determined so far. CEIOPS has therefore called upon the industry to describe approaches for measuring such effects. Further changes are expected in the supervision of a company's subgroups. In principle, CEIOPS assumes that major groups will use internal models for calculating solvency capital requirements. But the burden involved for companies in connection with subgroup supervision should be kept within reasonable bounds. On top of this, there could be further capital requirements for insurers whose parent companies are located outside the European Union. Interested parties were asked to submit their comments by 12 September 2006. At the public hearing on 7 September, experts from the industry, actuarial institutes, and associations discussed some of the open points. The majority of participants agreed that diversification effects should be considered in calculating solvency requirements, thus fundamentally confirming the trend of the debate to date. A controversial issue, on the other hand, was the introduction of capital add-ons. Some European states are advocating a very extensive introduction of capital add-ons, whereas others view them as only justified in exceptional situations. The European Commission has declared that it is seeking a high degree of convergence.

Quantitative impact studies – QIS2

The June issue of the Solvency II Newsletter contained information on the terms of reference of the second quantitative impact study. According to initial, preliminary evaluations, more than 500 European insurers, including many smaller companies, took part in the study. This series of investigations, whose focus has included calculation of the solvency capital requirement with a standard formula, is considered one of the biggest challenges for the EU, but also for European insurance companies of different sizes, legal form and corporate structure, in connection with the planned introduction of solvency rules. However, the results do not allow any conclusions to be drawn about an insurance company's actual capitalisation for solvency purposes. This is due to the fact that the standard formula is not yet fixed and the calibration not final. But provisional analyses permit the conclusion that the market risk will be the predominant risk driver for life insurers, whilst the underwriting (technical) risk will be the most significant risk category for property-casualty insurers. A point worth noting is that, even though only a few insurance companies were able to complete this study in full, it appears that the insurance industry is becoming increasingly conscious of the extent of the forthcoming changes. The series of studies has not yet been concluded. In order to assess actual capitalisation for solvency purposes, further studies are necessary. CEIOPS has announced a third impact study for April 2007. Until then, numerous discussions regarding the calibration and choice of model must be reckoned with.

QIS3

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Cf. http://www.ceiops.org/content/view/14/18/.

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Comité Européen des Assurances Impact assessment study The question of what effects on insurance products and markets insurers expect for themselves and their clients was the core topic of the impact assessment study initiated by the CEA in summer 2006. This was carried out in connection with the EU's Solvency II impact assessment. The large number of respondents shows that the insurance industry is already familiarising itself with the basic principles and requirements. The following findings are emerging: § Insurers will have to make additional efforts not only to rethink their risk management but also to be in a position to introduce appropriate risk-based controls. Companies are becoming increasingly aware of the need to develop innovative insurance products, but there is still a tendency to "wait and see". The greater the size of a company, the more likely it is that it will use internal models for calculating solvency capital requirements.

§ §

How far existing insurance products will be adjusted to satisfy the new solvency standards remains to be seen. The final results are expected in October 2006, and a summary of them will be published in a European Commission report on 7 Solvency II impact assessment. German Insurance Association (GDV) Harmonisation in the measurement of technical provisions So far there are no harmonised rules within Europe that would provide for comparability in the valuation of technical provisions. Consequently, there is sometimes great variation in the risk margins included in claims reserves. The European Commission's aim, however, is certainly not to stipulate one procedure that is to be applied by all insurance companies in the same way. On the contrary, its declared objective is to point out and allow different approaches which, however, will have to comply with certain uniform EU principles. Such principles will include a definition of the required safety level. Even if there are still no binding rules, measurement looks very likely to be based on market values in future. The German Insurance Association has made initial efforts to single out possible approaches for portfolio valuation of future cash flows for incurred losses ("best-estimate claims reserve") using, for example, § § § § § § the chain ladder method, the marginal sum method, the bootstrapping method, the Bornhuetter-Ferguson method, the incremental loss ratio method, the Munich chain ladder method,

but also measuring the uncertainty ("the provision for adverse deviation") involved in best-estimate claims reserves, e.g. using § § the quantile approach, the cost-of-capital approach.
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The GDV's analysis currently relates only to motor third-party insurance. Initial results lead to the conclusion that the use of market values will produce lower claims reserves. The reasons given for this are: § Portfolio measurement instead of individual measurement (balance within the portfolio)
Cf. subitem "Solvency II impact assessment". The detailed analysis can be found in the GDV report „Portefeuillebewertung von Schadenreserven am Beispiel der Kraftfahrzeg-Haftpflichtversicherung“, cf. http://visportal.gdv.org/archiv/Oeffentlich/Schaden/Allgemein/R_1598_2006.html .

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§

Discounting of claims reserves

A general point is that, regardless of the methodology chosen for calculating technical provisions, companies will have to concern themselves at an early stage with ensuring the requisite data is available. European actuaries – Groupe Consultatif Groupe Consultatif Versicherungstechnis guidelines for its che Rückstellungen Solvency II work At regular meetings of its representatives with the European Commission and representatives of CEIOPS, the Groupe Consultatif again made clear the main guidelines underlying its Solvency II work. These guidelines are reflected both in its collaboration with the CEIOPS working groups and in its responses to the various enquiries from the EU and CEIOPS. The chief elements are: § § § § § Security for the policyholder Risk-based principles and market consistency, together with a decision on calibration (risk tolerance) that has to be taken by political bodies Europe-wide harmonisation in order to create a level playing field Groupe Consultatif as a professional association – not as a lobby organisation Difficulty for Groupe Consultatif in providing significant help for purely political decisions

Also at these meetings, the Groupe Consultatif presented its ideas – currently still under development – regarding the future role of actuaries within Solvency II. It is proceeding on the assumption that the new solvency regulations in Europe will give rise to additional tasks and responsibilities for actuaries, which will have to be prepared for in good time. Solvency II glossary: Joint project of Groupe Consultatif and CEA Together with the European Insurance and Reinsurance Federation, CEA, the Groupe Consultatif is preparing a glossary of the most important terms in connection with Solvency II. It has become evident that particularly for work on solvency, it is extremely helpful if all involved have access to uniform definitions. In July, a first draft (with almost 200 terms) was sent to those involved. Requests were made for additional specialist input and comments in the case of several definitions. It is planned to publish the first version of this glossary in November 2006. International Actuarial Association/regulators IAIS Work is also proceeding on fundamental points of general solvency regulations 9 at international level. The IAIS publications for new solvency systems are further milestones achieved by the international regulators on the path to a consistent and transparent method for evaluating the solvency of insurance companies. Other publications are already planned:

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International Association of Insurance Supervisors.

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Finally, in May 2006, the draft of The IAIS Common Structure for the Assessment of Insurer Solvency, announced in the fourth Solvency II − Newsletter, was published. This draft contains a description of a risk-based method for assessing solvency. The IAIS takes a close look at the different roles of technical provisions on the one hand and capital requirements on the other. Whereas the technical provisions represent the level the insurer needs to fulfil its obligations, the level of the capital requirements provides additional security for the other risks. The IAIS advocates that a solvency balance sheet should provide the basis for the solvency system. Dependencies between the assets and liabilities sides – e.g. the technical provisions and investment risks – should be taken into account, as well as diversification effects across different risk classes. The resultant requirements for solvency capital should be covered with sufficient capital elements. Regulatory financial requirements should contain all the risk factors that reflect an insurer's risk exposure. The IAIS here refers to the five main risk types 10 already proposed by the IAA : underwriting risk, credit risk, market risk, operational risk and liquidity risk. This new IAIS publication, The IAIS Common Structure for the Assessment of Insurer Solvency, is being prepared by the IAIS Subcommittee "Solvency and Actuarial Issues". An initial consultation on it has already taken place. A new draft with a further consultation phase is expected shortly. The IAA is working closely together with the IAIS here, in the status of a special observer. In addition, there are also several observers from the insurance industry taking part.

If you would like more information on this subject, please contact:
Michael Lucas Dr. Rolf Stölting Kathleen Ehrlich Tel.: +44 18 65 26 82 18, Tel.: +49 89 38 91-52 28, Tel.: +49 89 38 91-27 77, E-mail: mlucas@gcactuaries.org E-mail: rstoelting@munichre.com E-mail: kehrlich@munichre.com

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International Actuarial Association.


				
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