Solvency II

Andrew Mawdsley

Overview

• The challenges in preparing for Solvency II

• Adequate financial resources

• Supervisory Review Process

• Disclosure

• Timeline

• Questions for you

Solvency II – Three-pillar approach

New focus for supervisorLevel of harmonisation

Group supervision

More pressure from capital markets, investors and

shareholders

Market-consistent valuation of assets and liabilitiesEconomic Capital

Validation of internal models

Quantitative capital requirements

Technical provisionsMinimum capital requirement

(MCR)Solvency Capital Requirement

(SCR)

Qualitative supervisory review process

Corporate GovernancePrinciples for internal control

and risk managementORSACapital add-ons?

Disclosures

Enhance market discipline through public disclosures

Annual FCR and Solvency reports

Provide additional (non-public information to the supervisors

Pillar 1: Pillar 2: Pillar 3:

The Challenge Ahead

• Governance – ORSA, Risk Management, Systems.

• Supervision of insurance firms – Risk based, prospective approach, proportionality

• Burden of Proof

• Demonstrating Adequate Financial Resources – Pillar 1

• Use and Approval of Internal Models – Use Test, Data

• Disclosure

Pillar 1 – Demonstrating Adequate Financial Resources

• Technical Provisions– Best estimate– Risk margin

• Solvency Capital Requirement (SCR): – Firms should hold capital to cover a 1/200 event (99.5% confidence level)

over a 1 year horizon– Enables undertakings to absorb significant losses– Breach → supervisory action

• Minimum Capital Requirement (MCR): – Unacceptable capital level below this point– Should result in a proportion of the SCR (25-45%)– High quality capital – Breach → potential withdrawal of licence

Pillar 1

Standard Formula

Pillar 2 – Risk Management System

• Pillar 2 is very important from a supervisory perspective

• SII seeks to promote high and consistent risk management standards

• Art 43 requires firms to– Have effective risk management systems – Consider all risk exposures, both current and possible– Have a risk management system that is fully integrated

into the organisation

It is not just about the SCR!

Pillar 2

• Own Risk and Solvency Assessment (ORSA):– Art. 44 requires firms to assess the level of risk in their business

and the level of solvency required to mitigate those risks

• Other issues:– Outsourcing (Art. 38)– Responsibility of management body (Art.40)– General Governance – Requirements set out (Art. 41)– Fit & Proper – Requirements set out (Art. 42)– Internal control system requirement (Art. 46)– Internal Audit requirement (Art. 46)– Actuarial Function requirement (Art. 47)

Pillar 2 - Challenges

• Adoption of new information and control infrastructure

• Embedding this new infrastructure in the business

• Verifying and documenting the new procedures

• Demonstrating to the Financial Regulator that the internal model is used in the governance, risk and capital management processes of the firm (Use Test)

• Doing the above for a small firm

Pillar 3 - Disclosure

Harnessing market discipline for supervisory purposes

• Supervisory Disclosure (Art. 31, 52)– Laws, regulations– SRP methodologies– Exercise of options– Capital Add-ons

• Company Disclosures (Art. 51,53-56,256)– Solvency and Financial Condition Report– Very detailed report

Supervisory Review Process

• Risk Based Approach – Probability vs Impact

• Off-site and On-Site Review

• Emphasis on On-Site Review– Convergence in approach– Directly assess compliance– Presentations, interviews, file review– Supervisory Actions

• Stress Testing

Getting to Solvency II

Timeline

Questions for you?

• Do you really understand what Solvency II is about?

• Have you completed your gap analysis?

• What operational, business and strategic issues does Solvency II create?

• Will your firm be ready for Solvency II?

• What questions will the Financial Regulator ask you?

• What clarity do you need on Solvency II?

Conclusion

• Many challenges in preparation for Solvency II

• Preparations should not focus on Pillar I requirements

• Pillars II and III are very important

• Different approach to supervision

• Undertakings should ensure clarity on Solvency II

Thank youThank you