Why don’ t we yet have Solvency II?

FERMA Forum on Risk Management

Maastricht, 30 September 2013

Prof. Karel Van Hulle

KU Leuven and Goethe University Frankfurt Former Head of Insurance and Pensions EC

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Insurance Regulation: a challenge

• The insurance sector is the only major economic sector for which there is not yet an agreed international accounting standard nor an agreed international solvency framework

• Insurance regulators usually have less resources that their banking colleagues

• Insurance and insurance regulation are not considered very exciting

• Insurance is the most complex sector in financial services

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Insurance in a risky world

• Insurance risks (ageing, health, natural catastrophes, new technologies)

• Regulatory risks (new solvency regime, consumer protection, SII’s, banking agenda)

• Low interest rate environment

• Lack of knowledge about the insurance business model

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Insurance Risks

• Privatisation of parts of social security (health insurance, long term care)

• New challenges: pensions – climate change

• New technologies: will the system function as we have designed it? Will human beings function as planned?

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Regulatory risks (1) Solvency reform

• Growing awareness that a risk based solvency regime is necessary

• Fear for the consequences of the risk logic

• Can we model everything?

• Difficult dialogue between actuaries, supervisors and the industry

• Cultural shock: first major reform since 30 years

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Regulatory risks (2) Consumer protection

• Changes in supervisory architecture (twin peaks and others): link between prudential and market conduct supervision

• Increased recognition of consumer protection after financial crisis

• Reflection in agenda’s of FSB, IAIS, OECD, EU and EIOPA

• Increasing number of regulatory initiatives

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Regulatory risks (3) SII’s

• Are insurers systemically relevant?

• Is it possible to distinguish between different types of insurers?

• What is traditional insurance?

• What policy measures should be applied to SII’s?

• Should there be a resolution regime for SII’s?

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Regulatory risks (4) Banking agenda

• Financial crisis started in banking

• Low interest rates are there to help banks to recover

• FSB tends to focus its regulatory agenda on banking with a distant look at insurance

• Insurers are often seen as the ideal solution for providing capital to banks

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Regulatory Risks (5) The international agenda

• Common Framework for the supervision of internationally active insurance groups

• Do we need a global capital standard?

• Relationship between IAIG’s and SII’s

• Extension of IAIG regime to other insurers?

• Enforcement of ICP’s and role of FSAP’s

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Low interest rate environment

• Solvency I does not require insurers to take account of the consequences of a low interest rate environment

• Impact on life assurance and non-life

• Role of insurance supervisors (see EIOPA)

• Japanese scenario?

• Future of long term guarantees?

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Lack of knowledge about the insurance business model

• Insurers are not the best communicators

• Insurance is complex

• Lobby around long term guarantees not always to the point

• Lobby around calibration of investments in the context of Solvency II not always in line with sound risk management

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Solvency II: the magic solution?

• Enthusiastic reception of 2007 Commission proposal

• Key elements of that proposal: – Market consistent valuation

– Total balance sheet approach

– Two capital requirements

– Confidence level: 99,5% VaR over one year

– Possibility to use internal models

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Solvency II: 3 pillars and a roof

Pillar 1: quantitative requirements

1. Harmonised calculation of technical provisions

2. "Prudent person" approach to investments instead of

current quantitative restrictions

3. Two capital requirements: the Solvency Capital

Requirement (SCR) and the Minimum Capital Requirement

(MCR)

Pillar 2: qualitative requirements and

supervision

1. Enhanced governance, internal control, risk

management and own risk and solvency assessment (ORSA)

2. Strengthened supervisory review, harmonised supervisory

standards and practices

Pillar 3: prudential reporting and public

disclosure

1. Common supervisory reporting

2. Public disclosure of the financial condition and solvency

report

(market discipline through transparency)

Group supervision & cross-sectoral convergence

Groups are recognised as an economic entity => supervision on a consolidated basis (diversification benefits, group risks)

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Solvency II: the real world

• Financial crisis also relevant for insurers?

• Is the proposed confidence level too high?

• Different confidence levels for life and non-life?

• Is VaR the right measure? Does it produce procyclicality?

• Should the calibration of risks only be based on mathematical calculations or should it also look at the business reality?

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S II: limits of economic theory

• Extreme observations come from off-model events, not from improbable events within models

• Limits to probabilistic reasoning

• The importance of stewardship

• Is the efficient market hypothesis still justified?

• Do we have a “homo economicus”?

• Actuaries should exercise more judgement and frame this in convincing narratives rather than to rely on spuriously accurate mathematical projections based on past experience (John Kay)

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Omnibus II and Solvency II

• Sectoral adaptation of insurance legislation to the new supervisory architecture

• Proposed by the EC in February 2011 as amendment to Solvency II Directive of 2009

• Specification of powers of EIOPA

• Transitional measures for Solvency II

• Change in date of entry into force of Solvency II

from 1 November 2012 until 1 January 2013

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The problem of the long term

• Role of the insurance industry in long term investment

• Role of the insurance industry in providing long term guarantees

• Who will bear the tail risk for life and pension products offered by the insurance industry?

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Negotiations of Omnibus II

• Lisbonisation of Solvency II

• Equivalence and transitional equivalence

• Financial crisis: – Market turbulence produces artificial volatility

in calculation of long term guarantees

– Low interest rate environment

– Problems of transition from Solvency I to Solvency II (discount rate)

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Omnibus II and Solvency II

• It needs two to tango

• Priority given to the urgent resolution of a difficult banking regulatory agenda

• Quick fix Directive of September 2012 moves start date from 2013 to 2014

• Intense lobbying creates uneasiness in the Council and in the EP

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Solvency II: for when?

• Failure to agree on Omnibus II has stalled further developments since 2009

• Entry into force likely to move from 2014 to 2016

• Trilogue negotiations likely to finish in October 2013

• EIOPA to issue guidelines in 2014 in order to assist insurers and supervisors

• Levels 2 and 3 measures to follow quickly after publication of Omnibus II

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Role of EIOPA

• From CEIOPS to EIOPA

• Leadership role for technical issues concerning insurance supervision (RTS)

• Representation in colleges of supervisors

• Binding mediation, peer reviews

• Supervisor for cross-border insurance groups?

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Concluding Remarks

• Insurance remains the great unknown

• The insurance industry will become increasingly important in this risky world

• Without sound riks management and a risk based solvency regime, insurers will not be able to deliver

• Not everything can or should be regulated