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International Regulatory Developments
Simone Brathwaite, FSA, FCIA, CERA
Principal
Oliver Wyman
December 2, 2010
An Introduction to Solvency II
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We will be highlighting the regulatory developments out of Canada and Solvency II
EU – Solvency II model
Financial Stability Board
“Leading” standard setting bodies
IAA
Global Financial crisis/Systemic risk solutions
Cross-sector issues/Regulatory Arbitrage
190 IAIS member jurisdictions/regulatorsBermuda, Barbados, Jamaica, Trinidad, Brazil, Mexico, Japan, Korea, India,
Singapore, NAIC, 56 US jurisdictions…
Leading National regulators: eg
Canada
UK
IAIS Most influential benchmark for national regulators
Australia
Swiss
Basel II & III
Solutions to implications of IFRS4
SII Equivalence United States
Many bodies driving global regulatory change A simplification of the key interactions
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Motivation – the change was long overdue– Solvency I was inept with dealing with the inherent risks of the modern insurance industry– Some EU regulators (e.g FSA, FTK) were forced to revamp their frameworks before Solvency II Process was slow, but to be expected– The leading EU regulators were able to guide the development of SII over the last 6 years – But still needed to consider the realities of the implications on the various member countries and
their industries Proposed outcome- not perfect but still pretty advanced – “leaped-frogged’ many existing frameworksImplementation date – January 2013– All EU companies were advised to participate in QIS 5 for a final chance to help establish the final
calibration of the solvency testImpacts the global industry – Will impact IAIS’s new initiatives – Impacts countries with companies who do significant transactions with EU companies, including
- International reinsurers – in non-EU countries (third countries) – Bermuda, Barbados- EU Group companies with subsidiaries outside of EU (AXA, ING, Global reinsurers)- Non-EU Group companies with subsidiaries operating in Europe (e.g RGA)
Solvency II is unquestionably the most significant regulatory change for the insurance industry that is happening right now
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Solvency II –3 pillars
Demonstrating adequate Financial Resources
Ensuring an adequate system of governance, aims to embed Solvency II into the business
Public Disclosure serves a different purpose from private regulatory reporting of information to supervisors
Pillar 2System of Governance
ORSA – own risk and solvency assessment
Supervisory review process
To assess quality of firm’s risk management
To determine if add-on capital is required
Pillar 3Private and Public Disclosure
Disclosure requirements
– Forward looking
– Relevant
– Public disclosure focused on needs of market participants
– E.g. annual report on Solvency and Financial Condition.
Market-consistent value of assets and liabilities
SCR – Solvency capital requirement @ 99.5%
– Standard model or internal model
MCR- absolute minimum capital requirement
Pillar 1Quantitative requirements
SOLVENCY II
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Non-Life Insurance SCR
Structure of the Solvency Capital Requirement under Solvency 2 (SCR)
Solvency II – Pillar 1’s risk based capital framework
Pillar One prudence objective for the SCR is to leave less than a 1 in 200 chance that capital will prove inadequate over the next 12 months
Market-consistent value of assets and liabilities
SCR – Solvency capital requirement @ 99.5%
– Standard model or internal model
MCR- absolute minimum capital requirement
Pillar 1Quantitative requirements
SCR
Deferred Tax Adjustment Basic SCR Operational Risk
SCR
Market Risk SCR
Health Insurance SCR
Counterparty Default Risk
SCR
Deferred Tax Adjustment
FX Risk
Property Risk
Interest Rate Risk
Equity Risk
Spread Risk
Illiquidity Risk
Premium & Reserve
Risk
Catastrophe Risk
Concen-trationRisk
Long-Term Health
Short-TermHealth
Workers Comp
Mortality Risk
Longevity Risk
Disability Risk
Expense Risk
Lapse Risk
CatastropheRisk
Revision Risk
Source : Morgan Stanley, Oliver Wyman Joint report: “The Tide is going out” for further details
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Group SolvencyRequires the aggregation of capital requirement
Eliminates double-counting
1. See Oliver Wyman/Morgan Stanley Sept 2010 Joint Report “The tide is going out” for further details
An allowance for diversification benefits
Market risk is calculated from the impact of specified adverse market stress scenarios.
The proposals include a ‘dampener’ to reduce pro-cyclicality, Market risk
Life Risks
Non life riskNon-life underwriting risk capital is determined by applying standard factors to premiums and reserves
The individual capital requirements for different risks are combined using ‘correlation matrices
Life underwriting risk is based on stress-testing the assumptions
Stresses largely based on industry averages and expert opinion
SCR –Solvency Capital requirementKey characteristics of the standard model
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Morgan Stanley / Oliver Wyman proprietary QIS5 model estimates a decline in the solvency ratio for the listed European insurers from ~200% to 135%.
Solvency 2 will be a catalyst for a fundamental reappraisal of traditional insurance business models
The transparency brought by Solvency 2 will expose the economic volatility of balance sheets
We see reinsurers as relative winners, while small insurers including many mutuals may struggle
European insurers may become competitively challenged in markets with ‘non-Solvency 2 equivalent’ regimes
Will be a reference model for the IAIS and other jurisdictions reforming their capital frameworks to be congruent with IFRS 4
Key implications of Solvency II
International Regulatory Developments
Allan BrenderSpecial Advisor, Regulation SectorOffice of the Superintendent of Financial Institutions Canada
December 2, 2010
- A Canadian Perspective on Capital
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Agenda
The current situation w.r.t. financial reporting and capital
Introduction of IFRS in Canada
Changing capital requirements (MCCSR)
Pillar II
Own Risk and Solvency Assessment (ORSA)
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The Current Situation
Canada uses GAAP statements for regulatory purposes
We are committed to one set of financial statements
We have had a sophisticated regulatory capital requirement (MCCSR) since 1992
Has been updated from time to time; more can be done
Moving towards an advanced approach – internal models; our work on this has slowed down due to our experience with models for variable annuities
Supplemented by stress and scenario testing (DCAT)
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Introduction of IFRS
IFRS comes into effect in Canada on 1 January 2011
All IFRSs adopted verbatim from IASB
For insurance, not many significant changes in 2011
Some small adjustments to MCCSR for 2011 because of adoption of IFRS
The major challenge and change will come with the introduction of Phase II of IFRS4 on insurance contracts
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IFRS4 – Phase II
IASB published an exposure draft (ED) this summer
Comment period ended on Tuesday, 30 November
In principle, the ED is close to Canadian valuation methodology, particularly to the Policy Premium Method (PPM) which was replaced in 1995 by our current Canadian Asset Liability Method (CALM)
Assumptions: best estimate plus explicit margin
Recognize all policy cash flows
(Gross) policy premium basis
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IFRS4 – Phase II
IASB and IFRS4 will not recognize any link between a company’s policy liabilities and the assets it uses to support those liabilities
The valuation discount rate is, for many, the main issue with the ED
Current Canadian method, CALM, recognizes
Cost of expected asset defaults
Asset / liability mismatch
Therefore, with the introduction of IFRS4 – Phase II, required capital (MCCSR) must be adjusted to make complete provision for credit and ALM risks
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Changing Capital Requirements
We remain committed to a single set of financial statements
However, the capital requirement may not always be based upon numbers in the financial statements
Began planning for a new capital requirement in 2005/6
Formed the MCCSR Advisory Committee with industry
Slow progress, which came to a standstill with the emergence of the global financial crisis (GFC)
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Effect of the GFC on Variable Annuities
Valuation of VAs was primarily based upon the use of internal models
Company models were required to be approved by OSFI
Since most companies did not sufficiently hedge the financial risks, when equity markets suffered a severe decline, VA liabilities experienced a huge increase, especially since we are dealing with a non-diversifiable risk
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Effect of the GFC on Variable Annuities
This VA experience raised two significant issues:
The use of company-specific (internal) models
Calibration
Controls, use test, etc.
Recognition of (the absence of) hedging
Market consistent methodology
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Adapting MCCSR to IFRS
Need a consistent view of liabilities and capital – i.e. the right hand side of the balance sheet
It is clear that policy liabilities under IFRS4 will not make reference to the particular assets used by an insurer to support those liabilities
Therefore, policy liabilities will take no account of credit or ALM risks
Provision for these risks must be contained wholly within required capital
Work is underway to develop these new pieces for MCCSR
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Redesigning MCCSR
Total Asset RequirementImmunize capital structure from changes in accounting into which OSFI has virtually no inputDetermine the total assets we want an insurer to hold to support a product portfolioSubtract from this total the liabilities determined by financial reportingThe balance is required capital (SCR)Need an independent minimum capital requirement (MCR)
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Redesigning MCCSR
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Redesigning MCCSR
First, select a time horizon
For each risk, select an extreme shock that the insurer should survive over the time horizon
Required capital for that risk is the sum of
Experience under the shock during the time horizon
Difference between the terminal provision and the initial policy liability
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Redesigning MCCSR
For Solvency IITime horizon is one yearTerminal provision is best estimate liability at the end of the year
This is related to the accounting notion of exit value that was being considered by IASB at the time the Solvency II legislation (Directive) was enacted
Today, financial reporting is focused on fulfillment valueCorrespondingly, our approach to capital is changing
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Redesigning MCCSR
OSFI is unlikely to introduce correlation between risks
Solvency II structure:
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Redesigning MCCSR
We will likely return to the question of an advanced approach and the use of internal models
Can reflect specific relationships between risks in a model
Acceptance of advanced approach by the regulator / supervisor involves acceptance of the possibility that required capital may be less than that produced by a standard approach
For this reason, supervisors require pre-approval of models and conditions on their use
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Three Pillar Approach to Solvency
Similar for both Basel Committee for Banking Supervision (BCBS) and the International Association of Insurance Supervisors (IAIS)
Pillar I: capital requirements
Pillar II: company specific
Pillar III: disclosure, to encourage market discipline
e.g. OSFI requires life companies to disclose an analysis of earnings by source (IASB is moving to this approach for the income statement)
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Pillar II
Involves supervisory action on individual company basis
Control levels
Possible additional requirements
Involves company management action
Risk management
DCAT / stress testing is part of this
Own Risk and Solvency Assessment (ORSA)
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ORSA
A company should analyze and know the type and degree of risks it faces
It should have a view on total capital needs
Not just those specified by the regulator /supervisor
Economic capital
Generally requires a sophisticated internal model
IFRS4 Phase II ED seems to assume all companies have such models
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ORSA
It would be a serious error to treat ORSA as a compliance exercise
Ultimately, regulators are much more interested in companies that are safe, well run and know what they are doing than in having companies merely comply with legal requirements
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Forthcoming IAA Publications
The IAA Solvency Subcommittee (of the Insurance Regulation Committee) is preparing two useful and practical papers designed to help actuaries (and others) in this work:
A paper on internal models
A paper on scenario and stress testing
International Regulatory Developments
Bob Diefenbacher, FSA, MAAA
SVP – Life Reinsurance
Manulife Reinsurance
December 2, 2010
Solvency II Equivalence Issues
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Agenda
Definition of Equivalence
Equivalence and Bermuda
Equivalence and the US
Transition Countries?
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Background
Players
Member States = Country subject to Solvency II
Third-Country = Country not subject to Solvency II
CEIOPS = Committee of European Insurance and Occupational Pension Supervisors
Group Supervision – Concept that regulators should not just review specific legal entity, but should consider entire corporate structure
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Equivalence – Article 172
Article 172 – Reinsurance
Reinsurance with companies domiciled in equivalent third-countries shall be treated in the same manner as reinsurance with Member States.
Article 173 – Member States cannot require pledging of assets to obtain reserve credit if equivalent.
In the absence of equivalence, treatment of third-country reinsurance would be left to determination of Member States.
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Equivalence – Article 227
Article 227 – Group Solvency
Applies to situations where parent company in a Member State has a subsidiary in a third-country.
If subsidiary’s country is equivalent, then the group supervisor may rely on solvency requirements and calculations of subsidiary in third-country.
Commission may identify certain countries as equivalent.
If the commission has not made a determination, then verification of equivalence is determined by the group supervisor, consulting with other authorities.
Commission may adopt criteria for determining equivalence.
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Equivalence – Article 260
Article 260 – Group Supervisor
Applies to situations where a company doing business in a Member State has a parent domiciled in a third-country.
If parent’s third country is equivalent, then Member State supervisor shall rely on the group supervision of the third country.
If parent country not deemed equivalent, then Member State can make its own determination of equivalence.
Article 261 also references the need for cooperation with third-country regulators.
CEIOPS has stressed the importance of setting up cooperation agreements.
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Pro’s and Con’s of Equivalence
Why Would A Country Want Equivalence? Insulates local companies from uncertainty associated with not having equivalence
Fair treatment for reinsurance assumed from EU. Protects local reinsurers business model. Avoids potential need for local companies to have to provide information to EU regulator in addition to local regulator.
Why Would A Country Not Want Equivalence? May require significant additional investment in resources to achieve equivalence.May require significant changes in existing solvency regime.
Local regulator may not agree with every principle of Solvency II.May impact market segments completely unrelated to Solvency II
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Current Status of Equivalence Deliberations
CEIOPS recognized that equivalence evaluations will be very labor intensive.
CEIOPS recommended the concept of a “First Wave” of third-countries chosen according to criteria based generally on supervisory regime, significance to EU companies, and existence of mutual recognition agreements.
European Commission Has Now Instructed CEIOPS to assess 3 Countries in the first wave:
Bermuda – Articles 172, 227, 260
Switzerland – Articles 172, 227, 260
Japan – Article 172
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Bermuda
Bermuda Monetary Authority (BMA) very committed to obtaining equivalenceBermuda is building a complete capital and solvency framework
Developing standard formula for required capitalCould use internal models, if approved.
Assets and liabilities modeled on a consistent basisEnhanced disclosure and governance requirementsDrafting group supervision rules
Becomes effective 2011-12 (varies by requirement and “class” of company)BMA working with industry task force to test different alternativesTransitional measures from current regime to new regime to be proposed soon
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US
State Based Regulatory System a ChallengeCEIOPS Identified Following Issues
National Association of Insurance Commissioners (NAIC) not a regulatory body
Does act as coordinator, and therefore could be a path to equivalence
Group supervision concernsProtection of information subject to state laws, which vary
US Industry would point out additional issuesNeither NAIC nor individual states can negotiate mutual recognition agreementsNewly created Federal Insurance Office might be a solution
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Transition Countries?
European Commission has floated the idea of a “transitional regime”to deal with third-countries not in the first wave.Third-countries chosen for transitional regime would:
Have same benefits as equivalence for a limited time periodNeed to satisfy certain criteria and commit to converging towards fully equivalence by end of period.Need to fully satisfy all equivalence criteria by the end of thetime limit
US seen as prime candidate for transition. Could also apply to Bermuda, Switzerland, or Japan if deemed notyet ready for full equivalence
Transition Still Being Debated in the EU
