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Solvency ii News April 2013
Solvency ii News April 2013
Solvency ii News April 2013
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Solvency ii News April 2013

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Solvency ii Association …

Solvency ii Association
http://www.solvency-ii-association.com

We are pleased to announce our updated Distance Learning and Online Certification programs:
1. Certified Solvency ii Professional (CSiiP) Distance Learning and Online Certification Program
http://www.solvency-ii-association.com/CSiiP_Distance_Learning_Online_Certification_Program.htm

2. Certified Solvency ii Equivalence Professional (CSiiEP) Distance Learning and Online Certification Program
http://www.solvency-ii-association.com/CSiiEP_Distance_Learning_Online_Certification_Program.htm

Register to receive Solvency II / Omnibus II related alerts, opportunities, updates, our monthly newsletter and limited time offers for our Solvency II / Omnibus II Training and Certification programs:
http://forms.aweber.com/form/28/1910009328.htm

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  1. P a g e | 1Solvency ii Association1200 G Street NW Suite 800 Washington, DC 20005-6705 USATel: 202-449-9750 www.solvency-ii-association.comDear member,Todaywewill start withGabrielBernardino, Chairman of EIOPA.Just beforethat, I want you tosee a jobdescription:BaselII/ III and SolvencyII risk specialist, Mandarin Speaking!!!Basel III Risk Specialist - Mandarin Speaking Leading GlobalInvestment Bank, LondonALeading Global Investment Bank isExpanding the Regulatory RiskFunctionwiththe hire of a Basel III Risk Specialist for their LondonGroup.- Basel III RegulatoryRisk Specialist- LeadingGlobal Investment Bank- MandarinSpeaking- London, UK- 50,000+ Excellent Bonus BenefitsAs a key member of the riskgroup you willbecommunicatingextensively with seniormanagement on a global scaleincludingdirect contact withsenior management inHong Kong and Shanghai and will thereforerequireMandarinspeakingskillsat businessSolvency ii Associationwww.solvency-ii-association.com
  2. P a g e | 2level proficiency.An expert in regulatoryframeworks,you will have practicalunderstandingof Basel II/ III and knowledgeof SolvencyII ICAAP isalsohighly preferred.This is a mid-level position withinthe group and will require a minimumof 3 years industry experiencewithin theLondon and/ or InternationalFinancial Markets.It is never toolate tolearnMandarin. Is lookseasy!Amazingjobdescription…Just one slight problem withthisjob description:You cannot haveknowledgeof SolvencyII ICAAP … simplybecausethere isnothing likea Solvency II ICAAP… perhapstheymean SolvencyII ORSA(OwnRiskandSolvencyAssessment, thePillar 2 document).It remindsme another job description, wheretheyrequired 5+ years ofBasel III experience. Provided that BaselIII wasendorsed at theend of2010,theycould hire someoneafter 2015…Solvency ii Associationwww.solvency-ii-association.com
  3. P a g e | 3Interview with GabrielBernardino, Chairman ofEIOPA, conducted by ChristophBaltzer, VersicherungsWirtschaft(Germany)Insurersseem tobethevictimsof ascenario offinancial repression, especiallywithlowinterestrates. What wouldbethe consequencesof thepolicy of cheap moneyfor insurers?We see this in some countriesin theEU wherealowinterest rate environment startsbeinga bigchallengefor some typesof products, especiallywhenyou have got long term guarantees.We at Eiopahave identified it alreadyin 2011.We have run the first stresstest exerciseparticularlyon low interestenvironment, becausewesee it assomethingwhichis approaching.Theexperienceof Japan showeduswhat can be the consequencesofsuch a scenario.It‘s the responsibilityof thesupervisoryauthoritiesto be proactiveonthis.This is an area whereweneed to be attentive.We have identified certain vulnerability: there arecompaniesthat couldfaceproblemsif thislow interest rate scenario will be maintained.There are number of supervisors in the EU that have already takensteps, but earlier in March EIOPA issued its Opinion, in which werecommend a coordinated supervisory response to the long lasting lowinterest rates.Solvency ii Associationwww.solvency-ii-association.com
  4. P a g e | 4Gladly, on the insuranceor pension market westill have sufficient timetodeal with it, providedthat weidentify risks sufficientlyin advanceandtake necessaryactions.That‘sa differencecomparing to thecrisis in thebanking sector, whereyou need to act immediately.At the same time some new productsthat wereintroduced beforethecrisis should be adopted tothe new economic environment: insurancecompanies should reflect on thetype of productsand the type ofguaranteesthat theyare issuingtothe market.DoesSolvencyII help to prepareforthisscenario?One misunderstandingthat needsclearlyto be spelledout is that it‘s notSolvencyII that provokeschallengestobusiness.It‘s the economicenvironment.SolvencyII makesone difference:You need torecognizeit earlier.If you have a market consistent valuationof assetsand liabilitiesit willbemuch more clearthat you have a challengein your portfolio.If you continueto havea valuation that doesnot reflectthemarket, thenyou can pretend that there isnoproblem.But theproblem exists.SolvencyII makesthis transparent and that isgood for consumers, forcompanies and alsofor supervisors.We needtohave a preventive supervision.Supervision should not be there to act whenthe fire is alreadyin yourhome.Solvency ii Associationwww.solvency-ii-association.com
  5. P a g e | 5Supervision should be there toprevent that the fire occurs.Versicherungswirtschaft wrotein 2003 that SolvencyII wouldbein forcein 2006. Doyou believethat SolvencyII will bein forcewhenyour termfinishes?My term finishesin 2016.That‘sa date that isstill possibleto haveSolvency II in place.Before that weneed a number of political decisions, but I believethatSolvencyII will be in place.It‘s fundamental from a supervisoryperspective becausewenow have aregimethat doesnot respond tothe risks.We have toremember whywestarted SolvencyII.Thepurposewasto increasepolicyholder protection and incentivizebetter risk management.And from all thework that wehavedonein SolvencyII there isalreadysomepositiveevolution in the wayinsurersmanage risks.Wehave seen abankingcrisisin 2008. What weforget about is theinsurancecrisisin theyears 2001until 2003. This wascaused byequityinvestments, reserve deficienciesand unprofitable businessin manylines.Doyou think ascenario of this kind will still bepossibleunderSolvenyII?No regulatoryregimecan avoid crisis.There is no perfect regime.SolvencyII bringsmuch more awarenessof risks at an earlystage.Solvency ii Associationwww.solvency-ii-association.com
  6. P a g e | 6From the side of the companies it‘s a fundamental change of culturewhen companies while investing in markets, need to understand therisksthat theyare running.Thesupervisorsin their turn will alsohave necessarytoolsandinformation in order to look at thecompaniesfrom therisk-basedprospective.Is thisa zero failure system?No.There arenozero failure systems. But there hasbeen progress.You mentioned thecrisisof 2001until 2003.Theindustryhas learned from that and weincorporated it in Solvency II.Thepush for increasedrisk management and for better understandingbycompanieswhentheyinvest in certain typesof assets– thesearethelessonslearnedfrom that past.This is fundamental right now:one of theconsequencesof the lowinterest ratesis that insurancecompaniesare searchingfor yield.It‘s bound to happen that they go to other types of investment.But then it‘sfundamental that theyhave a good understanding of thoseclasses.And that‘swhat SolvencyII brings.Insurerscriticize what theyrefer toasartificial volatilityin thebalancesheetsunderSolvencyII. Someeven talk about irrationalityof capitalmarkets. Doyou understand this criticism?SolvencyII will givefiguresthat will be more volatilethan in thecurrentSolvency ii Associationwww.solvency-ii-association.com
  7. P a g e | 7situation.It wasclear from thebeginning.Everybody wasalertedto that.What haschanged is themagnitudeof this volatility.We didn‘t have ashigh volatilitiesin thepast aswehad in therecentyears.We have todeal withthisvolatility in thesystem.That‘swhat wearedoingright now withthe long term guaranteeassessment (LTGA), whichpreciselyfocuseson that.TheLTGAis trying tounderstand what kind of adjustmentsweneedtomake totheregimetodeal withartificial volatility.But not all volatilityis artificial.Muchof it is representativeof what is in the market.I don‘t want to discusswhethermarketsare rational or not.If you have long term liabilitiesand longterm assetsand you have a verygood match betweenthem, your numbersare lesspronetohave thisvolatility.If you have a huge level of mismatchingthen on the one side you aretakingadvantageof opportunitiesin the markets,but you have a risk.But for some longterm liabilitiesweneed to havesome adjustmentstocopewith the fact that the productsand theliabilitiesare long term andtheshort term volatilitiesin the assetshave a meaning, but theydon‘thavean economicmeaning for thetype of liability that insurershave.This is theadjustment that weare trying to effect right now.Solvency ii Associationwww.solvency-ii-association.com
  8. P a g e | 8Theregimewassincethe beginningbased on theideathat wewant toseethereality.And the realityis that marketsare more volatilenowadays.We needto recognizethe reality.What wouldbeapositivepolitical solutionforthat?An agreement on OmnibusII whichis preservingthe fundamentalelementsof SolvencyII, preservingthemarket consistent valuation thatwehave got in SolvencyII and preservingthe principlesof a robust andprudential regime while consideringalsotheeconomic nature of theliabilities.I think that wehavegot some good proposalson the table.Government bondsare categorized asnorisk investments. Doyou thinkthat this isagoodwayto tackleproblemsof state debt?Morethan any other systemSolvencyII takesintoaccount thereality offinancial markets,includingon sovereigns.In a SolvencyII balancesheet, sovereignswill be assessedat marketvalue.It‘s much more advanced than other regimes.Any kind of influence that markets are putting on any kind of sovereignsin Europe right now, is taken into the Solvency II numbers immediately,without anykind of adjustments.Thenthere is the element of capital requirementson top of that.But it‘simportant to understand themagnitude.Solvency ii Associationwww.solvency-ii-association.com
  9. P a g e | 9If you look at technical provisionsand capital requirements,technicalprovisionsrepresent 80 to85 percent of a balancesheet.Capitalrequirement is just a small item comparedtothat.By having market consistent evaluation in the technical provisions andin the balance sheets, you have already a huge reflection of all the riskstheassetshave, includingsovereigns.Now theperceptionof sovereign risk iscompletelydifferent from what itwasten years ago, whenwestartedtodevelop thesystem.Going forward weneed toconsider this.What is alsoimportant tounderstand is when something should bedone, it should be done for all sectors.We cannot have a different appreciation of sovereign risk for insurersand for banks.It needsto be done for the financial system asa whole.And it‘s alsoimportant totakedue attention to thetime when wearedoing this.It‘s not a good policyto changethis whenyou are still in a crisis.How doyou evaluate the SwissSolvencyTest?It‘sin usesince2006 andis in force alreadyfor twoyears.Theprinciplesare very much alignedtoSolvencyII.I think it‘svery good that theystartedtoimplement thesystem becauseSwitzerland is an important insurancemarket and EIOPAhasvery goodrelationship and closelycooperateswiththe Swissauthority FINMA.Solvency ii Associationwww.solvency-ii-association.com
  10. P a g e | 10We can observe challengesbut alsoa good outcome from theimplementationof a risk-basedregime in Switzerland:wehave seensomechangesin behavior in themarketsand in theproductsthat Swissinsurerssell.But let‘sbe frank: it‘smuch easier for onecountry to implement a regimethan to have a decision on a tablewith27different approaches.What arethemost important tasksfor Germaninsurerstotackle on their waytoSolvencyII?There aresome companiesthat are more prepared and othersthat arelessprepared.That‘swhyweare developingguidelinesfor the preparationphaseforSolvencyII.We have definedareaswherewewant supervisorstoensure thatundertakingsare prepared: governance, risk management, pre-application of internal models, elementsrelatedtotheOwn Risk andSolvencyAssessment (ORSA), the informationtobe provided tosupervisors.Theobjectiveof theseguidelinesisto help marketsand supervisorstohavea clear ideaof how topreparetothenew regime.For examplethere is a need to makeprogressin the systems andprocessesthat are necessarytodeliver high qualitydata tobe providedbycompaniesand further analysed by supervisors.This is fundamental for therisk+based environment.Soby our guidelinesweare not introducingSolvencyII earlyon, but weexpect national supervisorstostart implementingtheseelementsin aconsistent and convergent wayand torequest from companiestopreparethemselvesin theseareasin order tobe in a good shape whenSolvencyII is enforced.Solvency ii Associationwww.solvency-ii-association.com
  11. P a g e | 11It is a win-winsituation for both companies and supervisors.Is thereasituation wheresystemic riskbecomesaproblemfor insurersand reinsurers?We understand what is systemic riskin banking.Looking at the insurancesector it‘salsochallenging.But thetype of businessis different.Thematuritiesof businessaredifferent.If you talk about traditional insurancebusiness,wedon‘t see muchevidenceof all thesefactorsthat can bringsystemic risk.But insurerscan involve themselvesin some typesof businesswhichismuch more pronetosystemic events, for exampleexposurestocreditdefault swaps.Systemic risk in theinsurancemarket ismore a questionsof theactivitiesrather than insurersby themselvesbeingsystemic.If you have a type of business that is much more leveraged, where youhave maturity transformations like you have on the banking side, if youwalk and run like a bank, then you need to be treatedlike a bank.Are thecollegesof supervisors abletocopewiththeir task, especiallyifyou look at thevastnessof some insuranceenterprises.It‘s important that supervision isperformed in a waythat it can deal withreality.It‘s important that welook at the risksfrom a group perspective.In Europe wehave recognizedthis much earlier thanmany jurisdictionsaround the globe.Solvency ii Associationwww.solvency-ii-association.com
  12. P a g e | 12In the late 1990swehad an insurancegroup directive whichsaidthat it‘snot sufficient to supervisesinglecompanies, but to do supplementarysupervision at a group level.With SolvencyII weare recognizingthe reality: The groupsmanagetheir businessin amuch more centralisedwayand thisneedsto bereflectedin supervisionin order toavoid duplicationsand doubleburdensbut at thesame timein order tohave a better perception of thereal risks that are run at the group level.That‘swhycollegesof supervisorsare suchan important tool.Theprogressthat theyhave made ishuge.Therole of EIOPAin these collegesis tomake sure that thereis aconsistent and convergent supervision.This is a process. We have still some room for improvement.Doyou think amorecentralized approach wouldbebetter for thebigfinancial institutions?There arestepsthat need to be taken in this area.I think the best waytodo that is tobuild up on the roleandresponsibilitiesgiven to usby the Regulation establishingEIOPA.We can build a step by step approach towardsa more centralizedsupervision.I don‘t believein ruptures.That needstobe an evolution and not a revolution.We gain from havingmore centralizationin some areas.For exampleinternal models are fundamental for the new regime.Solvency ii Associationwww.solvency-ii-association.com
  13. P a g e | 13It‘s important that there is good understandingof how the modelsworkon individual and groups‘level Here wecould have an approachcentralized by EIOPAbecauseit‘snot possiblethat all the authorities inall the countries whereyou have companieswithina group, will have thesameexperienceimmediatelytodeal withit.But it needsto be a step by step approach.In UK it is nowprohibitedforbrokers totake commissions.Doyouthink that this will improveconsumer protection?Intermediariesare the visiblefaceof theindustry towardsconsumers.Thequalityof the informationand advicethat is provided is crucial.There area number of thingsto improve.But isit all about disclosure?Is disclosurethe key issue?Thereality provesthat this isnot the case.Disclosure is important but it‘snot the panacea.I think this is not fair tosay―We gave all the information to theconsumer, but he doesn‘t understand it, soit‘shis problem‖That is not a policyI wouldrecommend from a perspectiveof consumerprotection.First of all there aredifferent typesof intermediariesand businessesweare talking about.In life insurance it‘simportant that the consumershave good knowledgeof the commission the intermediariesare taking.Solvency ii Associationwww.solvency-ii-association.com
  14. P a g e | 14This is a contract for manyyears, soin life insurance themandatorydisclosureshould bethe rule.If you look at the non-life sideyou should have the right toget theinformation.But the conditionsfor non-life contractscan be changed on an annualbasis,theyare not fundamental for your decision.Theconflict of interest ismuch lessrelevant for non-life products.What is important in consumer protection then?You need to understand what consumersare worried about. Evidencestell usthat in manycasesthecommission theintermediarygets,is not fundamental forconsumers.Theywant tohave a good advice.But if theyneeded topay for that advicedirectly, then theywouldnotbuytheproduct.But asa societydoyou want peopleto be lessinsured?Sobanning thecommissionsthis measure needstobe well analyzed.Shouldpension fundsbeobliged tofulfill therequirementsof SolvencyII?It‘s not our intentionthat pension fundsshould followSolvencyII.When weadvised theEuropean Commission, wesaid that there aresome areas,whereweseean advantage of applying the same basicstructure Pension fundsare dealingwiththe similar kind of risk, soit‘simportant for the protection of membersand beneficiariestohave goodrisk management, good governance, better transparencyetc.Solvency ii Associationwww.solvency-ii-association.com
  15. P a g e | 15But wesaid alsothat a straight forwardapproachlike in SolvencyII isnot the best solution for pension funds.There aredifferent typesof security mechanismsaround Europe.It‘s important in anykind of solvency regime that thecalculation ofliabilitiesand thevalue of the assetsare taken more realistically.We made a QIS exerciseand wewill have preliminaryresultsfrom thistest at the end of Marchor in the beginningofApril.Someof the QIS optionswereconsistent withSolvencyII, otherswerelessconsistent.But wenever said that weshould follow SolvencyII.Solvency ii Associationwww.solvency-ii-association.com
  16. P a g e | 16EU-US INSURANCE DIALOGUEAGREES HIGH LEVELPROJECT PLANTheSteeringCommitteeof the EU-U.S.InsuranceDialogueProject toincreasemutual understandingand enhancecooperationmet in Basel, Switzerlandand agreed on a high level workplanfrom 2013to2017.Theparties achieved agreement on aprioritizationof objectivesand a schedulefor the implementation of theinitiativespreviouslyagreed upon by the SteeringCommitteeanddescribedin the―Way ForwardDocument‖ (December 2012).As part of the five-year plan, an agreement wasreached to move forwardin 2013with particular focus on thoseinitiativesrelating to professionalsecrecy/ confidentialityand reinsuranceand collateral requirements, aswell asto begin work on some other initiativespertainingto solvencyandcapital requirements,group supervision and on-siteexaminationpractices.TheSteeringCommitteeanticipatesa public forum in late 2013toreporton the years achievements,tolaunchcollaborative workon supervisorycollegesand to givestakeholdersan opportunityto sharetheir thoughtson best practicesand experiencesregardingsupervisorycooperationandcoordination.Solvency ii Associationwww.solvency-ii-association.com
  17. P a g e | 17Meeting of the G20Finance Ministers andCentral Bank GovernorsUpdate by the IASB andFASBConvergence projectsThis report isa high-levelupdate on thestatusand timelineof theremainingconvergenceprojects.This includesan update on the impairment phaseof our joint projecton financial instruments(included in theappendicesto thisreport).BackgroundIn the past ten years, sincethe US FinancialAccounting Standards Board(FASB) and the InternationalAccounting StandardsBoard (IASB) (theboards) signedtheNorwalkAgreement in 2002, wehave maderemarkableprogressin improving and converging major globalaccountingstandards.In 2006, theboardsagreeda Memorandum of Understanding (MoU)that identifiedseveral short-term and longer-term convergenceprojectsthat would bring themost significant improvementsto IFRSand USGAAP.TheMoU wasupdated in 2008and thenagain in 2010.Achievements and challengesMost of theshort-term projectsand several of thelonger-term projectshavebeen completed or are nearingcompletion.Solvency ii Associationwww.solvency-ii-association.com
  18. P a g e | 18In 2012theboardsmade significant progresson theremainingjointprojectsand theycontinueto appreciatethe importanceof developingconverged accountingstandards.The boards have achieved converged solutions for Revenue Recognitionaccounting and will be exposing converged proposals for accounting forLeases.There have, however, been some challengestodeveloping completelyconvergedsolutions,especiallyfor the Impairment and InsuranceContractsprojects.For theImpairment project, it hasbeen a challengetobring together thedifferent perspectivesof the boards‘respectivestakeholdersand thedifferent marketsin which such stakeholders conduct their primarybusinessactivities.While the goal continuesto bethe development of a converged Standardfor impairment, theextent of future convergencein thisproject willdepend, in part, on the feedback that isreceivedduring theboards‘respectivecomment periods.However, it is alsoimportant tonote that under both setsof proposalsthe provisionsfor loanlossescontinuetobe based on the sameinformation set, updated for changesin lossexpectations.Developing a converged solution for theInsuranceContractsprojectmay be more difficult.IFRS doesnot currently includeaccountingrequirementsfor insurancecontracts,sothe IASB needsa final Standard urgentlyand will beundertakinga targetedre-exposure of itsproposals.TheFASB hasexistingmodels for insurancecontractsbut will initiallybe exposing proposed amendmentsfor public comment in mid-2013.Solvency ii Associationwww.solvency-ii-association.com
  19. P a g e | 19Thedifferencein thescope of thequestionsin these exposuredocumentsand theneed for theIASB toissuetimelyguidancewill make achieving afullyconverged solution for the InsuranceContractsproject challenging.Financial instrumentsClassification and MeasurementDuring 2012,theboards workedtogether toeliminatedifferencesin theirrespectiveclassification and measurement models and haveconvergeddecisionsin thefollowingareas:•Contractual CashFlow CharacteristicsAssessment: a financial assetwouldbe eligiblefor a measurement categoryother than fair valuethrough profit or lossif the contractual terms of thefinancial asset giverise to cash flowsthat are solely paymentsof principal and interest on theprincipal amount outstanding, whereinterest is considerationfor thetimevalueof moneyand for credit risk.•BusinessModelAssessment: theassessment of the businessmodelwouldapplytothosefinancial assetsthat ‗pass‘ theassessment of thecontractual cash flow characteristics.Financial assetswouldqualify for amortisedcost accountingif the assetsare held within a businessmodel whoseobjectiveis tohold the assetsinorder tocollect contractual cashflows.Thefrequencyand nature of saleswouldprohibit some financial assetsfrom qualifying for amortised cost.•Fair value through other comprehensive income: financial assetswouldbemeasured at fair value through other comprehensive income if they‗pass‘the assessment of the contractual cash flowcharacteristicsand areheld within abusinessmodel whoseobjectiveinvolvesboth holdingthefinancial assetstocollectcontractual cash flowsand sellingfinancialassets.Solvency ii Associationwww.solvency-ii-association.com
  20. P a g e | 20•Fair value through profit or loss would be the residual measurementcategory that would include all assets that ‗fail‘ the assessment of thecontractual cash flow characteristics.Given the different stagesof development of the classification andmeasurement phasesof their respectiveprojects,(the IASB ismakinglimitedamendmentsto IFRS9 Financial Instrumentswhereasthe FASBis proposingcompletely new guidance), theboards‘exposure documentswill not be identical.TheIASB published its Exposure Draft in November 2012.Theseproposed amendmentswereintended tofurther align theboards‘classificationmodels, addresssome of the insurancecommunity‘sconcernsabout theinteractionwithaccountingfor insurancecontracts,and clarifythe existingclassificationand measurement requirementsforfinancial assets.Thecomment period ended on 28March 2013.TheFASB expectstoissuea second Exposure Draft on classificationandmeasurement in February 2013and will conduct outreach withstakeholdersduring theexposure period.Thecomment period will end on 30April 2013.Theboardsare planningtobegin joint redeliberationsabout thefeedbackreceivedon theproposalslater thisyear.Thetiming of theissuanceof final requirementswill depend on thenature and extent of thefeedback received.Impairment (Loan LossProvisioning)This is probablythemost important phaseof our project tooverhaul theaccountingfor financial instruments.Solvency ii Associationwww.solvency-ii-association.com
  21. P a g e | 21While the boards worked jointly to develop an ‗expected loss‘ approachto impairment, US stakeholders raised numerous concerns about earlydraftsof theso-called ‗three-bucket‘approach.Themost significant concernsrelated to the use of twodifferentmeasurement approaches—aportion of the expected lossesfor all new orpurchasedfinancial assetsand a full lossrecognitionapproach forfinancial assetsthat haveexhibited‗morethan insignificant deterioration‘.TheFASB believed it wasnecessaryto addresstheseconcernsbeforemoving to an Exposure Draft.Toaddresstheseconcerns, theFASB developed a different expectedlossmodel wherebyat eachreportingdate, an entitywouldrecognise anallowancefor credit lossesfor itscurrent estimateof all expectedcreditlosseson financial assetsheld at the reportingdate.Thesame objectiveappliesto all financial assetsheld in anyperiod;however, themeasureof the allowancewouldbe commensurate withthecurrent assessment of risk for the financial assetsheld.In late December 2012the FASB publisheditsExposureDraft.TheFASB‘s comment period endson 30April 2013.TheIASB decided tomaintain the concept of the ‗three-bucket‘approachbut will revise it toaddressconcernsthat had been raisedabout thepoint at whichfull lifetimeexpected lossesshould berecognised.Therevised model will result in an initial recognition of a portion of thelifetimeexpected losses, withfull lifetimeexpectedlossesbeingrecognised only once a financial asset significantlydeteriorates(ie tothepoint that an economic lossis suffered beyond the level that wasoriginallyanticipated and priced intothefinancial asset).Solvency ii Associationwww.solvency-ii-association.com
  22. P a g e | 22TheIASB isawareof the importanceof publishing itsproposalsassoonaspossible, and will publish an Exposure Draft in thefirst quarter of2013.There will be a 120-daycomment period.Theboardsappreciatethe importanceof converged requirementsin thisarea and continueto have open linesof communication.However, asnoted above, challengesto achievinga converged solutionincludebringing together thedifferent needsof the respectiveboards‘stakeholdersand thedifferent marketsin whichsuch stakeholdersconduct their primary businessactivities.It is alsoimportant tonote, however, that under both setsof proposalsthe provisionsfor loan lossescontinuetobe based on thesameinformation set, updated for changesin lossexpectations.Theboardswill continue todiscussdevelopmentsastheymoveforward, and participatein eachother‘soutreach during both boards‘exposure periods.Thecomment periodswill have some overlap and the boards willconsider public commentson both approachesduring redeliberations.The timing of the issuance of final requirements will depend on thenature and the extent of feedback received, but the boards expect tocompletedeliberationsin 2013.HedgeAccountingTheobjectiveof theIASB‘s project isto improve hedge accountingbymore closely aligningthe accountingwitha company‘s risk managementactivities, therebyimproving financial reporting.Solvency ii Associationwww.solvency-ii-association.com
  23. P a g e | 23As previouslydiscussed, theHedgeAccounting phaseof theFinancialInstrumentsproject is not a joint project.However, the FASB sought commentsfrom itsstakeholderson theIASB‘s HedgeAccounting Exposure Draft, and will consider theseandthedecisionsreached during redeliberationsin conjunctionwithfeedbackon its ownproposals,whenit recommencesitshedgeaccountingdeliberations.Other projectsLeasesLease obligationsarewidelyconsidered to be asignificant source of offbalancesheet financing.Theobjectiveof theLeasesproject is toimprove financial reportingbylessorsand lessees,in particular by recognisingleaseson thebalancesheet.Theboardshave completeddiscussionson theLeasesproject and haveagreedtore-exposethe revisedproposalsfor identicalstandards on leaseaccounting.Theboardsplan topublish exposure draftsin thesecond quarter of 2013with a 120-daycomment period.During the comment period, the boardswill conduct additional outreachwith users of financial statementsand withentitiesthat undertake leaseactivities.Theboardsplan tojointlyredeliberatetheproposalslater this year. Thetimingof theissuanceof the final requirementswill depend on thenature and extent of thefeedback received.Solvency ii Associationwww.solvency-ii-association.com
  24. P a g e | 24Revenue RecognitionTheobjectiveof this project isto improve financial reportingby creatingidenticalstandards on revenue recognitionthat clarify the principlesthatcan beapplied consistentlyacrossvarioustransactions,industries andcapital markets.Theproject appliestoall contractswithcustomers(exceptleases, financial instrumentsand insurancecontracts).In December 2012theboardscompleted thesubstantive redeliberationsof the recognition and measurement principlesin the 2011ExposureDraft.Theboardsplan toredeliberatethe remainingtopics, includingthescope, disclosure, transitionand effectivedate, in the first quarter of 2013and issuefinal standards in mid-2013.Insurance ContractsTheobjectiveof this project isto eliminateinconsistenciesandweaknessesin existingpractice and to provide a singleprinciples-basedStandard to account for all insurance contracts.While theboardsareworkingtogether on theInsuranceContractsprojecttheyhavereached different decisionson several basic matters.For example, while both boards have agreedtomeasuretheinsuranceliability using a current measure of theestimatedcost to fulfil theobligation, theboardshave reacheddifferent decisionson several aspectsof the model, includingtherecognitionof changesin estimate, theinclusion of a risk margin in the measurement of the liabilityand thetreatment of acquisition costs.Theboardsfinalisedtheir joint discussionsin January 2013.Solvency ii Associationwww.solvency-ii-association.com
  25. P a g e | 25Theobstaclestofindinga convergedsolutionfor the InsuranceContractsproject may be difficult toovercome.In particular, thedifferent decisionsreachedbytheboardsare a result ofdifferent starting points(IFRS currentlydoesnot includeaccountingrequirementsfor insurancecontractssothe IASB needsa final Standardurgently, whereastheFASB isproposingamendmentsto itslong-standinginsurancemodel).Due to the importanceof the project and in view of the extensivedebatetheIASB hasundertaken over theyears, the IASB will only seekfeedbackon five keymatterswhich have significantlychanged sincethe2010ExposureDraft.TheIASB hopesthat this approachwill avoid further unduedelays infinalisingthis much-needed Standard for insurancecontracts.TheIASB planstopublish this Exposure Draft in thefirst half of 2013.TheFASB plansto publish itsfirst Exposure Draft in mid-2013.Investment EntitiesTheInvestment Entityproject was,in themost part, jointlydeliberated.However, the FASB is addressingthe accountingfor investment entitiesmore broadlythan theIASB did, asthe latter‘sfocuswassolely on anexemption from consolidation.Consequently, theboards‘ final requirementswill be similar but notidentical.TheIASB issueditsfinal requirementsin October 2012.TheFASB plansto finaliseitsredeliberationsand issuea final Standardin thefirst half of 2013.Solvency ii Associationwww.solvency-ii-association.com
  26. P a g e | 26The new Risk DashboardSolvency ii Associationwww.solvency-ii-association.com
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  30. P a g e | 30EIOPA Risk Dashboard – Background noteExecutive SummaryEIOPA publishesa Risk Dashboard on a quarterly basis, in accordancewith itsobligationsunder the EIOPARegulation1and followingaframeworkdeterminedin cooperation withtheother ESAs, the ESRBandtheECB.TheRisk Dashboard is based on mechanical aggregation of indicatorsand additional expert judgment if deemed necessary.Besides publicly available market data, extensiveuse is madeofcompany data whichis reported by 30 largeand important insurancegroupsfrom theEEAand Switzerlandunder EIOPA‘s quarterlyfast-track reporting.Withinthe common structure agreed upon by theESAs, theESRB andtheECB, theRisk Dashboard isdesignedto be flexible, soEIOPA canreact quicklyto upcoming risks whichare deemed necessaryto becovered.EIOPA expectsthe Dashboardto graduallyevolve further, takingfeedback by the addresseesof this product intoaccount.ContextAs part of the new European legislation, EIOPAaswell asthe otherESAsand theESRB arecalledupon to ―develop a common set ofquantitativeand qualitativeindicators(risk dashboard) toidentify andmeasure systemic risk‖.Thelegislationfurther stipulatesthat thesedashboardsshould beconstructed in cooperationbetweentheESAsand ESRB.Solvency ii Associationwww.solvency-ii-association.com
  31. P a g e | 31In response to this requirement, the ESAs, together with the ESRB andthe ECB have determined a set of general features for all dashboards tofollow:- Each riskdashboardwill be constructedbased on the same set ofrisk categories:macrorisk, credit risk, market risk, funding andliquidityrisk, profitability and solvencyrisk and risksresultingfrominterlinkagesand imbalances.Furthermore, each institution hastheoption to add categoriestoallowfor sector specific risks (e.g. insurancerisk).- It wasnoted that all Risk Dashboardsshould be constructed on aflexiblebasisin order toalloweach authority toreflect themostimminent risksidentified.- Further development and implementationof the Risk Dashboardsshould be taken forward individuallyby each of theauthoritiesconcerned.However, the ESAs and ESRB should continueto work togethercloselyin this regard to ensure interplay regardingtheunderlyinginformation presentede.g. consistencywhen thesame indicator isused in different Risk Dashboards.ApproachWork on theEIOPARisk Dashboardhassincebeen brought forwardbythe Financial StabilityCommitteeof EIOPA.In definingthemethodology for the Risk Dashboard,the Committeehasconsideredtheapproach taken by other institutionsin the field of riskassessment, for instanceby the IMF2.TheRisk Dashboard hasbeen created togive a structuredview of riskstothe insurancesector and theenvironment in whichit operates,inSolvency ii Associationwww.solvency-ii-association.com
  32. P a g e | 32order to facilitatea regular assessment of theserisksand possiblemitigatingpolicyactions.In creating it, carehasbeen taken tokeep the dashboard asconcise,forward-lookingand flexibleaspossible.Furthermore, it isworthnotingthat thedashboard is designed asa high-level tool showingthemost relevant trendsand riskson a macro level.As significant differencesbetweenindividual institutionsexist, thefindingspresented are not alwaysapplicableto all EU insurers.MethodologyIndicatorsAset of currently 40 quantitativeindicatorsforms thebasisof the riskassessment presented.These indicators, which signal potential risks and vulnerabilities for theEuropean insurance sector as well as its resilience, are generated usingboth supervisoryand publicly availabledata.This data isused – and in some casescombined – asthebasisof the riskassessment for each indicator.Given that thedistribution of risksand vulnerabilitiesisat least asimportant asitscentral tendency, the risk indicatorsare, wherepossible,assessed by takingboth themedian and outliers(e.g. 10th or90thpercentiles) of theunderlying sampleintoaccount.Basedon thisinformationan initial risk score for each indicatorisderived.Thesescoresbasicallyserve asproxieswhencombining variousriskindicatorstoan assessment for the overarchingrisk category.Solvency ii Associationwww.solvency-ii-association.com
  33. P a g e | 33Risk categoriesTheindicatorsare mapped to aggregatedcategoriesof(1) macro risk,(2) credit risk,(3) market risk,(4) funding & liquidityrisk,(5) profitability & solvency,(6) interlinkages& imbalancesand(7) insurancerisk.Basedon theindividual risk scoresfor each underlying indicatoranaggregated riskscore for each categoryisgenerated by either- an unweightedaverage (for categories4, 6 and 7);- a weightedaverage referring to a long-term averageof actualportfolio holdings(for categories2 and 3);- a sub-aggregationwithinsome indicatorsof a risk categoryand anaggregationof these―sub-riskscores‖ by using the simpleaverageofor category1witha split in (1a) real-economyrisksand (1b) theriskinessof the insurancesector asperceivedby financial marketparticipants,ofor category3 witha split in (3a) asset siderisksand(3b) ALM matchingrisks, ofor category5 witha split in (5a) lifebusiness,(5b) non-life businessand (5c) total business.For a quick and comprehensiveinterpretation theoverall risk scorearevisualizedthrough four color codesin theRisk Dashboard.Solvency ii Associationwww.solvency-ii-association.com
  34. P a g e | 34Quarterlychangesare represented through arrows.Risk assessmentThemechanicallyestimated risk scoresper categoryform thebasisoftheriskassessment in the Risk Dashboard.Thesescoresare complemented by other information availableon risks,e.g. from stresstest results,topical risk analysesor other availabledata.If necessary, this informationisusedtoadjust the scores.This way, it is ensured that all availableinformation is used for the riskassessment and themost completepicture is generated.However, decisionsto changethe mechanicallyaggregated scores(i.e.expert judgment) are documented to ensure transparencyof thisprocess.Toensure flexibility, theRiskDashboardcontainsspacetoelaboratefurther on themost prominent risksin a ‗user-defined‘non-mechanicalway.Additional dimensionsof each risk (e.g. the potential impact aswellastimingaspects) havebeen derived partiallyon expert judgment aswell.Expert judgmentExpert judgment is consideredcrucial for complementingorsubstitutingthemechanicalprocessof the risk assessmentsand formakingforward-lookingstatementsabout theexpected evolution ofrisks.Theprocessfor adjustingthe initial risk scores(both upwardanddownward adjustment) by expert judgment isintendedtobetransparentandused consistentlyover time.Solvency ii Associationwww.solvency-ii-association.com
  35. P a g e | 35Any uncertaintyin the assessment and/ or element of judgment that willinfluencethe final assessment, such asriskmitigatingfactorswill bemadeexplicit and will be documented.Thetransparencyand documentationrequirementsshould ensure asufficient level of confidencein theexpert judgment.This confidencein expert judgment isimportant in order toproducecrediblerisk assessments.This confidenceshould be further maintainedby trackingtheadjustedassessmentsagainst actual experienceor new information that becomesavailable.Such ―realitychecking‖ is especiallyimportant wherethe expertjudgment leadstosignificant deviationsfrom themechanicalassessment or whereit hasa material impact on the overall assessmentoutput.Data sourcesData for the Risk Dashboardisobtained from both public sources(market data) and thequarterly supervisoryreporting of 30largeEuropean insurancegroupstoEIOPA(fast-track reporting).Data availabilityfor RiskDashboardpurposesis expected to improvesubstantiallywiththeintroduction of SolvencyII reporting.Indicators usedMacro riskAs macro risks are obviouslythe major domain of the ESRB‘sRiskDashboard, EIOPA‘scontribution focusesmainlyon insurance-linkedaspects.Solvency ii Associationwww.solvency-ii-association.com
  36. P a g e | 36Besides consensusforecastsof GDP growth, development of consumerpricesand unemployment rates,thissection thereforeencompassesthefinancial markets‘perception of the healthinessand profitabilityof theEuropean insurancesector.For this purpose, relative stock market performances of Europeaninsurance indices against the total market are assessed, as well asfundamental valuations of insurance stocks (price/earningsratio, price/ book-value ratio), CDS spreads and ratings/ratingoutlooks.Market riskMarket risk is,for most asset classes,assessed by analysing both theinvestment exposure of the insurancesector and an underlying riskmetric.Theholdingsgive a picture of thevulnerabilityof the sector toadversedevelopments;the riskmetric givesa picture of the current level ofriskiness.For equity investments, the relevant risk metrics are the implied volatilityas a short-term indicator and the price/ book-value ratio as medium-termindicator.Also for property investmentsthevaluation comesin asa risk metric, viathecurrent yield of commercial real estateinvestments.In addition, thecurrent level of long-term interestratesand some asset-liability matchingindicatorsare assessed, e.g. by comparing theduration of the bond portfolio (includingthe effect of derivativeholdings) withtheduration of technical provisions.Thedifferencebetweenguaranteedinterest ratesand investment returnscompletestheassessment in this risk category.Solvency ii Associationwww.solvency-ii-association.com
  37. P a g e | 37Credit riskFor measuringcredit risk theholdingsof credit asset classesarecombinedwithrisk metricsapplicablefor theseasset classes.For instance, the holdingsof government securitiesare combinedwiththecredit spreadson European sovereigns.Such indicatorsare alsoconstructed for theholdingsof bank bonds(secured and unsecured) and non-financial corporatebonds.Liquidity and funding riskGenerallyspeaking, insurersare lessprone to liquidityrisk thanbanks.As indicators,the lapserateof the life insurancesectorhasbeen usedwith a high lapseratesignalinga potential risk.Furthermore, holdingsof cash & depositsare used asa measure of theliquiditybuffer available,both in absolutetermsand asa share of lessliquidassets.Thelast indicatorused is theissuanceof catastrophebonds, whereavery low volume of issuanceand/ or high spreadssignal a reduction indemand which could form a risk.Profitability and SolvencyNinerisk indicatorswereconsidered in the determination of the riskscore for this category.While the return on equity providesan overall assessment of theprofitabilityin thewholesector, a more detailedbreakdownofprofitabilitytrendsisavailableby analysing thecombined ratio and theSolvency ii Associationwww.solvency-ii-association.com
  38. P a g e | 38return to premiumsfor non-life businessand the return on assetsfor lifeinsurers.Solvencyratios for both life and non-life insurerscompletethepictureinthisrisk categoryaswell asthe year-on-year changein capital&reserves.Interlinkages and ImbalancesUnder this section various kindsof interlinkagesare assessed, bothwithin theinsurancesector,namely betweenprimaryinsurersandreinsurers,betweenthe insurancesectorand thebanking sector, aswellasvia derivativeholdings.In addition, asan indicatoron imbalancesthedebt/ equityratioof theinsurancesector hasbeen included.Insurance RisksAs indicatorsfor insurancerisksgrosswrittenpremiumsof both life andnon-life businessare an important input.Both significant expansion and contractionare taken asindicatorsofrisksin the sector; theformer due to concernsover sustainability and thelatterasan indicatorof widespreadcontraction of insurancemarkets.Premiumsare alsoanalysed in comparison to insurers‘capital&reserves(insuranceleverage).Information on insurance lossesdue to natural catastrophesroundsupthisrisk category.Solvency ii Associationwww.solvency-ii-association.com
  39. P a g e | 39Solvency ii Associationwww.solvency-ii-association.com
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  44. P a g e | 44Interview with Gabriel Bernardino,Chairman of EIOPA, conductedbyNataša Gajski Kovačić, Svijet osiguranja(Croatia)In thebest scenario, thebeginningof SolvencyII implementation shouldbeeither in 2015or2016,asMr. Bernardinohasrecentlysaid.He addedthat thedate dependson thelength ofthelegal and political process.Previouslyit wasannounced that fullimplementation of SolvencyII will happen at thebeginningof 2014?What is thereason of thedelay of SolvencyII?First of all let me give you an overview of theEU legal processthatprecedestheimplementationof SolvencyII.We have a Level 1text – the SolvencyII Directive, whichwasadoptedin2009,it isa principlesbaseddocument.TheLevel 2text will contain detailed rulesof theSolvencyII regime.This document iscalledImplementing Measuresand will be preparedbythe European Commission.Finallywehave Level 3 & Technical Standards, whichconcernspurelytechnicalmattersand require supervisory expertise rather than strategicdecisionsor policy choices.TheTechnical Standardsare tobe preparedbyEIOPAand thenadopted by the European Commission.Solvency ii Associationwww.solvency-ii-association.com
  45. P a g e | 45TheEU trilogueparties (theEuropean Commission, theEuropeanParliament and theCouncil of theEU) still need todecidethe scope andthelegal basisfor theTechnical Standardsthat EIOPAhastodraft.This decision will be introducedin thesocalledOmnibusII Directive.Onlyafter the finalizationof the OmnibusII Directive, the Commissionwill come up withthe ImplementingMeasuresand EIOPA– withTechnicalStandards.Last year the triloguepartiesagreed that a final decision on theOmnibusII Directivecan be taken onlyafter EIOPAconductsthe Long TermGuaranteeAssessment (LTGA).EIOPA supportsthisapproach becausebeforemoving forward withSolvencyII weindeed need toagree on a sound and prudent regimefor the valuation of long term guarantees.On 28 January 2013welaunchedthisstudy and hope to present itsfindingsand our conclusionsin June 2013.Afterwardsweexpect that theOmnibusII Directivewill be finalized.Someinsurance companiescomplainthat theSolvencyII scheme favorsbiggerinsurerswhohavetheresourcestoeasilyadjust to thenewregime.Theycomplainthat thecost of preparation aretoobigalready.How doyou comment that?No, SolvencyII is a neutral framework.Already the level 1text statesthat the Directiveshould not betooburdensome for small and medium sized insurance companies.Solvency ii Associationwww.solvency-ii-association.com
  46. P a g e | 46And one of the meanstoachievethis objectiveis the proper applicationof the proportionalityprinciple.In our workrelatedtothedrafting of Technical Standards, wealwaystake intoaccount proportionalityaspectsthat are related tothesize, complexityor risk profileof insurancecompanies.As regardsthecostsof preparation, let‘saskourselves:dowewant tokeepthe existingSolvencyI regime?No, becauseSolvencyI is not risk sensitive, it containsvery fewqualitativerequirementsregardingrisk management and governanceanddoesnot providesupervisorswith adequateinformation on theundertaking‘srisks.Comparing to thecurrent regime, SolvencyII has a clear benefit – it is arisk& based regime, it helpscompaniestobetter understand andmanagetheir risks.SolvencyII is a hugestep in termsof transparencyasit will bringharmonizedreporting framework and reliabledisclosure.I am convinced that SolvencyII will providean appropriate basisforincreasedpolicyholder protection and will contributeto reinforcingfinancial stabilityin general.Thecostsof preparation will be higher for the companiesthat want touseinternalmodels for thecalculationsof their capital requirement.That will not be thecasefor thevast majority of companiesin the EU.Doyou think that Europeaninsurersareprepared forthetransition toSolvencyII?Wheredoyou expect thebiggestproblemstooccur?We are confident about the preparation level of insuranceundertakings.Solvency ii Associationwww.solvency-ii-association.com
  47. P a g e | 47At the same time wewant tousethedelayin SolvencyII implementationfor tackling possibleproblemsin a consistent and convergent wayandhere I wouldlike to mention EIOPAOpinion on interim measuresrelatedtoSolvencyII, whichweissued in December last year.In thisdocument weindicatedthat weseea great necessityin suchinterim measuresbecause there isa risk that due tothedelayof a finalagreement on SolvencyII, a number of European supervisorsmaydecidetodevelop national solutionsin order toensure sound risksensitivesupervision.Soinsteadof reachingconsistent and convergent supervision in the EU,different national solutionsmay emergetothedetriment of a goodfunctioninginternalmarket.EIOPA will develop Guidelinesthat are addressed tothe nationalcompetent authoritiesand that are related to such stableelementsofSolvencyII that are unlikelytobe influencedby the finalizedOmnibusII Directive.TheseGuidelineswill cover thesystem of governance, includingriskmanagement, ORSA, pre applicationof internal models, and reporting tosupervisors.I must saythat our initiativetodevelop the Guidelineswasapproved byEIOPA Board of Supervisors(BoS), whichconsistsof all thenationalsupervisoryauthoritiesof the EuropeanEconomicArea and alsoreceivedavery positivefeedback from theEuropean Commission.In April wehope to havethe first draft Guidelinesready.Afterwardswewill put them out for a public consultation.After thepublic consultationthe Guidelineswill be finalized and will betabledto EIOPABoard of Supervisorsin Autumn 2013.Solvency ii Associationwww.solvency-ii-association.com
  48. P a g e | 48As of 2014the Guidelinesare supposed tostart to be implemented,howeverweare fullyawarethat it will not be possiblefor thesupervisorstocomplywitheverything asof 1January 2014.Sohereagain wetakeintoaccount theproportionalityprinciple:whilepreparingtheGuidelinesweare considering their gradualimplementation.TheGuidelinesare focused on thepreparation for SolvencyII.With this step wewill ensure a smoother transitiontothenew regime,both by undertakingsand supervisors.Croatia is about tojoin theEU thusJuly– what big changescan weexpect in insuranceworld?As all the other EU members, Croatia will have to complywiththeEUlegislationand, thus, for examplewithEIOPA Guidelinesrelated to theinterim measuresfor theSolvencyII implementation or withtheGuidelineson complaintshandlingby insuranceundertakingsthat weissuedin 2012.I am confident that themembership in theEU will opentoCroatianinsurancemarket the possibilitiesfor future growth, while theEuropeanSystem of Financial Supervision will contributeto preservingthefinancial stabilityand enhancingconsumer protection in the Croatianinsurancemarket.Are you familiar withtheworkof insurersin Croatia?How doyou cooperate withour national supervisoryauthorityHanfa?Yes,the information exchangeamong competent supervisorsandEIOPA is one of thepurposesfor whichtheEuropean System ofFinancial Supervision (ESFS) wascreated.As regardsthecooperation, EIOPAstartedto prepare the groundSolvency ii Associationwww.solvency-ii-association.com
  49. P a g e | 49for welcomingthe Croatian Financial ServicesSupervisoryAgency(HANFA) toour Board of Supervisorsalready in 2011.In 2012HANFA became an observer of the BoS and started thepreparatorywork in order to comply withall the necessaryrequirements.Themembersof theHANFA Board and its staff membersalreadyactivelyparticipatein EIOPAactivitiessuch asthemeetingsof EIOPABoard of Supervisors, variouscommitteesand workinggroupsandEIOPA trainingsand seminars.Soonthe HANFA will become a votingmember of EIOPABoard ofSupervisors.Thetasksof our BoSare wideranging.TheBoS isthe main decision making body of EIOPA, it adoptsall theopinions,recommendationsand decisionsissued by our Authority;approvesour budget, annual and multi annual workprogrammesandannual reports.SoNational SupervisoryAuthorities closely participatein theworkofEIOPA and are awareof all our initiativesand achievements.Is theresome kind of special treatment towardsnewmembersinEIOPA, dotheyhave someperiod of adjustment?No, the preparation startedwell in advance and nospecial transitionperiod for theCFSSAwill be needed.When Croatia becomespart of theEU, what will your authoritiesininsurancepoliticsinCroatia be?EIOPA is responsibleto develop technical standards,that will becomemandatoryand guidelinesthat HANFA will need tocomplyor explain.Sothe regulatory frameworkwill be influencedby EIOPA.Solvency ii Associationwww.solvency-ii-association.com
  50. P a g e | 50Furthermore, EIOPAhasthepower to investigate possiblebreachesoftheEU Legislationin EIOPA‘s scope of activities.If EIOPAmakesa conclusion that the Breach of the EU indeedtookplace,theAuthority will issue a recommendation addressedtotherespectivenational supervisor.In some limitedcasesEIOPAaction can be applied totheindividualcompanies.But thismight happen onlyin casethenational authoritydoesnotcomplywith actionsrecommended by EIOPAor theEuropeanCommission.In thiscasethe Chairman of EIOPAhasa right topropose to theBoardof Supervisorsan individual decision addressedtoa financial institutionin whichrequiring the necessaryactiontocomplywithitsobligationsunder the Union law.Such a decisionmay require the cessationof any practice.Many insurersoperate ontheEuropeanand global level sotheyaresometimesconfronted withdifferent supervisory regimesorpractices;howcan that beresolved?Thefirst step is tobuild up a harmonized prudential frameworkin theEU.That is thepurposeof the Solvency II.Secondlyweneed toassurethat day to day supervisionof financialinstitutionsis done within a consistent framework.EIOPA will develop a SupervisoryHandbook that wouldwork asaguidebookfor supervisionin SolvencyII, settingout good practicesinall the relevant areasof supervision.Solvency ii Associationwww.solvency-ii-association.com
  51. P a g e | 51This handbook will foster the implementationof a more consistentframeworkfor the conduct of supervision.Furthermore, there isa strong role for the collegesof supervisors.In the end of 2012,91insurancegroupswith cross&border activitywereidentifiedin the European EconomicArea (EEA).Collegesrepresenta very important tool of group supervision becausetheyprovidenecessaryplatform for the gatheringand dissemination ofinformation especiallyin caseof concernsor emergencysituationsthatoccur.Collegeshelp todevelop a common understandingof the risk profile ofthegroups, toachievecoordinationof supervisory review and riskassessment at a group level aswell asto establishsupervisoryplansforthemitigationof risks at a Group level.TheRegulation establishing EIOPAempoweredour Authority toparticipatein the collegeswitha view tostreamliningthe functioningand theinformationexchangewithincolleges.Thestrategicgoal of our collegeworkis toset up consistent, coherentand effectiveEEA-widesupervision of cross-border insurancegroupsforthebenefit of both group and solosupervision.Every year weset ayearly action plan for collegesand alsopublish ourannual reportson thefunctioning of colleges.In the courseof 2012, EIOPAattendedalmost all collegemeetingsfor 75insurancegroups.We contributed to the workof collegesby developing a catalogueforregular information exchangeand by providingspecific presentationsincollegesabout EIOPA‘s regular assessment of risks facedby the EEAinsuranceindustry.Solvency ii Associationwww.solvency-ii-association.com
  52. P a g e | 52How will SolvencyII applyto pension funds?What canpension fundsexpect out of SolvencyII?Right now & nothing. The review of theIORP Directiveisa differentprocessand isin a different stage.We believethat occupational pension fundsalsoneed to have a muchmore risk basedregulation.As part of the processto advisethe European Commission on thereviewof the IORP Directive,, weconductedthe first QuantitativeImpact Studyfor occupational pensions.But sufficient time needstobe takentoget theright approach.At themoment wehavethree main conclusions.First, is that the requirementsand principlesthat wehave in Solvency IIon thegovernancesideshould alsobeapplied tooccupational pensionfunds.Theprinciples,especiallythe requirementsabout riskmanagement, arevery much relevant for occupational pension funds, too.But of coursetheyshould be applied using a proportionalityprinciple.Thesecond conclusionis about transparency.SolvencyII improvesinformation not onlyfor supervisorsbut alsofor alltheexternalsparties.We recommended the Commission for examplethat in caseof definedcontribution schemesa key information document shouldbe giventothepotential and already existing membersof the pension plan.This document should outlinecosts,charges,commissionsand risks.Solvency ii Associationwww.solvency-ii-association.com
  53. P a g e | 53Thethird conclusion is that alsoin theoccupationalpension fundsyoushould have an economicvaluation of assetsand liabilities.We needto prevent the situation whena problem is faced, but it istoolate to solve it.At the same time I usedtorepeat that wearevery much against acopy&paste exercisefrom Solvency II to IORP Directive.We dorealize thedifferencesbetweeninsurancecompaniesand IORPsandthesedifferencesshould necessarily be takenintoaccount.Your opinion on therolethat insurancecompaniesdealing withlifeinsurancehave in providingforwellbeingof elderlypeople?Insurancecompaniescan and do play a particularlyrelevant roleinprioritizingsecurityand longterm savings.Lifeinsurersare experts in risk management, theyare used todeal withdemographic, biometric and investment risks.Theyare very well placed tooffer good solutionsfor retirement savings.Due to thisimportant role, regulation and supervision aremuch relevanttoensurethat insuranceundertakingshave robust solvencyand that theyprovidepolicyholders withtransparent information about theproductsandtheir risks.Solvency ii Associationwww.solvency-ii-association.com
  54. P a g e | 54Interview with CarlosMontalvo, Executive Director of EIOPAConducted by Victoria Tozer Pennington, theRisk Universe (theUnitedKingdom)Therecentlyannounced further delay toOmnibusII havebeen greetedwith dismayby firmseager toseethefinal rulestoSolvencyII.How doyou account forthedelaysandwhat is your advice tofirms?CarlosMontalvoRebuelta:Acredibletimelinefor the implementationofSolvencyII is a must have.Regardlessof theseuncertainties, thereisa strongneed for risk-basedsupervision.This need hasbeen onlyreinforced by thelessonstaken from the currentcrisis.In order words,the ideaand theprinciplesof SolvencyII are more actualand valid than ever.Our advicetothe firms is not to wait until the politicaldiscussionsareover, but touse the timein order tobetter prepare for SolvencyIIinternally: tomakesure that the Boardsof firmskeep consideringSolvencyII a priority; and totake advantageof theinformation that theyare already collecting, aspart of suchexercise, in termsof betterunderstandingthe riskstheyface, and howto addressthem.In the absenceof a final agreement on Solvency II in the scheduledtimeline, EIOPAhasexpressed an opinion in order toensureandenhancesound risk based supervision and preparethe industry for thefinal SolvencyII Directive.Instead of reachingconsistent and convergent supervisionin theEU,different national solutionsmay emergetothedetriment of a goodfunctioninginternalmarket.Solvency ii Associationwww.solvency-ii-association.com
  55. P a g e | 55In order toavoid thisscenario EIOPAdecidedtodevelop guidelinesandtotakea lead in thepreparatoryprocessaimed at a consistent andconvergent approach withrespect tothepreparation of SolvencyII.EIOPA Guidelineswill allowsupervisorsand undertakingstobe betterpreparedfor the applicationof the new regulatory framework.Tocut a long storyshort, theguidelinesare an excellent wayfor allpartiestouse the extra timeof thedelayasa waytobe better preparedfor implementation.How have theindividual Member Statesof theEuropean Unionprogressedwith their adoption of SolvencyII and areyou confident allwill beabletoimplement thefinal rulesontime?Montalvo:The Member Statescan and must successfullyimplementSolvencyII and theyhave alreadystartedto make necessarypreparationsfor it.Somestepsin the right direction have alreadybeen taken, there is a goodworkalready in progress,but there arestill challengeswithregards to thewholeimplementationprocessboth for companiesand supervisors.Ignoring them wouldbe irresponsible.In your opinion howwill Solvency II serve to reducecost, complexityand riskforinsurancefirms?Montalvo:First of all, it is not possibleto eliminateor even reduce risks.Theinsurancebusinessisa risk-relatedbusinessthat by itsnature isbased on taking, managingrisksand making profit out of thoserisks.Theobjectiveof SolvencyII is not toreducerisks, but to allowcompaniestoproperlyunderstand, price and managethe risksthey face.SolvencyII will enhancebetter understanding of the risks, and suchSolvency ii Associationwww.solvency-ii-association.com
  56. P a g e | 56understandingwill help companiesto better managetherisksandtherefore, to make better decisions.This will createan immediatebenefit tothe undertakings.As regardscomplexity, complexityis particularlychallengingfor smallandmedium-sizedenterprises.SolvencyII is more complex than it wasoriginallyforeseen.Beyond theprincipleof proportionalityand itsapplication, wehavecurrentlyon our tablesuch initiativesaslookingfor thecalculationof theSolvencycapital requirements(SCR) and developing an IT tool tofacilitate it, or a toolkit to convert data required intoXBRL.We acknowledgetheproblem and together with industrywewant to findwaystotacklethe excessof complexityof the framework, becausecomplexityshould never bean obstacletotheclear benefitsof SolvencyII.Whyareinsurershaving such difficultycommunicating theimpact ofSolvencyII to thebusiness?Montalvo:Solvency II provides firmswitha lot of relevant informationfor them to run their business, and todo soin a more sound manner.But thisalsoimplieschangesand it is always challengingto explain thebenefitsof change, tosend themessagethat wemay havetochangeourapproachto certain risks, products… that are embedded in the normalfunctioningof the company, simplybecausetheycan threatenthefirmitself.Compliancewith therulebook is certainlynot thedriver towardsSolvencyII, asit only bringsthe downsideof it, costsand complexity,but not theupside, namely qualityinformation, understandingof risksandthesubsequent opportunities.Solvency ii Associationwww.solvency-ii-association.com
  57. P a g e | 57Therefore, a changeof approach, in termsof both action andcommunication, should takeplace todeal withthedescribedsituation.Therearesignificant data management issuesconnected withSolvencyII;doyou recognise thechallengesfirmsface and what advice doyouhavein thisarea?Montalvo:We are awareof the challengesoriginatedby reportingrequirementsand weareworking in order tominimize this burden forcompanies.Thedata challengescome from twosources:thevaluation of the activityusinga harmonised market consistent approach and the detailedrequirementsfor public disclosureand supervisory reporting.Themarket consistent valuation isa high_levelprinciple, which wassetearlyon in the process(Article 75of theSolvencyII Directive).EIOPA recognised from thestart thedata challengethat undertakingwill face and hasexpended maximum effort to allowundertakingstostart preparing themselves,by consultingon thedetailed expectationsregardingpublic disclosureand supervisoryreporting.Theimplied advice remainsthesame: continue(or urgentlystart for thelate comers) to prepare your internal systemstobe readyon time.EIOPA hasalsorecentlylaunched an IT development project (Tool forUndertaking) to make sure that all undertakingswill have accesstoatleast one costlesspossibility tocreatetheSolvency II reportingsubmissionsexpected by supervisors.TheORSA[OwnRiskandSolvencyAssessment] remainsachallengefor manyinsurers, whichhasnot beenhelped byalack of detailedguidancefrom theregulators.Given howmuchfirmsarestrugglingwiththis,doyou expect to offermoreguidanceoncethefinal rulesarepublished?IfSolvency ii Associationwww.solvency-ii-association.com
  58. P a g e | 58so,whenand on whichareas?Montalvo:The ORSAprocessmust be ownedby the company.We indicatethe aim of ORSAbut cannot providevery detailed guidancebecausewe don ‘t wan t to int erv ene in themanagement processesof companies and totell them how exactlytheyshould conduct theORSA.At the same time weunderstand theconcernsof industry and preciselybecauseof this, wealready conducted public consultation on ourpreliminaryviewson the ORSA.And this isnot theend of our workon ORSA, but a link tothe workweare doing in termsof supervisoryreview processand other areas.We planto continueinvolvingthe industryon how to enhanceunderstandingand how tomake the ORSAan operativetoolkit for thecompanies, a toolkit that wouldallow them to understand their solvencyposition, their risk challengesand the continuityof their business,beyond a oneyear time horizon.In termsof supervision, the ORSAshould be brought to a qualitativelevel and that is what EIOPAis alsoworkingon.Afinal point I think appropriatetoraiseon ORSAis itsuseasa waytoimposeadd-onsbysupervisors.If wewoulddoso, it wouldbe a one and done exercise,wewouldneverrealisticallybe able topretend that undertakingswould perform, for theirowninternal purposes,a seriousORSA exercise,but a complianceboxtickingone.Arecent survey showedthat althoughfirms (in theUK specifically) arewellontheir wellto implementingtheir internal models, sourcessaythat thebigger issueof passing theusetest couldbeaproblem.Doyou haveanyadvice on preparing fortheusetest?Solvency ii Associationwww.solvency-ii-association.com
  59. P a g e | 59Montalvo:Internalmodelsgobeyond a simpletoolkit to calculate capitalrequirementsbecausetheyare a fundamental management toolkit.On thebasis of this, sinceday one, theusetestbecame a cornerstoneofthewholeprocess.As part of the usetest, undertakingsneed to demonstratethat theinternalmodel is widelyusedin termsof decision making and plays animportant role in their system of governance, and that the model at alltimesreflectsthe risk profile of theundertaking.EIOPA is developingguidelinesthat will clarifytherequirementsrelatedtothe usetest.Theseguidelineshave alreadybeen pre-consultedwithselectedstakeholders.One of the most crucial points is that national supervisory authorities(NSAs) should asses individually the compliance with the use test foreach undertakingindividuallyaccordingto the requirements.Although there areminimum requirementsfor the use test, there isnodetailedand completelist of usesthat theundertakingshavetoabidewith.EIOPA recognisesthat theusesof the internal model will vary fromundertakingtoundertaking.NSAswill assesscompliancewith requirementsbasedonproportionality.Someusesmay not be materiallyimportant tothe undertakinggiven thenature of their business.DoesEIOPAhave anyinformation onthepreferred blend ofscenariosand lossdata from amodellingperspective?Solvency ii Associationwww.solvency-ii-association.com
  60. P a g e | 60Montalvo:Internalmodelsbydefinitionare tailored tothespecificneedsof individual companies.On that basisEIOPAcannot have any concretepreferred approach whenit comesto blend of scenarios and lossdata and in general to internalmodelsastheyare specificto companies.It is up to the undertaking to justify its own approach and methodologyto the supervisory authority as part of the approval process of the use ofan internal model for the calculationof the solvencycapital requirement.This justification includesdemonstratingboth that the approach isadequatetakingintoaccount the specificrisk profile of the undertaking,andthat the internalmodelsrequirementsrelated to test and standardsare fulfilled.Froman operational risk lossdata point of view, firms arecopingwithadearth of data and scaling issuesusingexternal lossdata.Has EIOPAdone anywork on this area or can you offer some advice tofirmson theissueof the preferred useof internal and external lossdata,sourcesof lossdata, and scalingproblems?Montalvo:EIOPAor more precisely, itspredecessorCEIOPShasperformed several studiesin order tocalibratethe Operational RiskCapital Charge.Thestudies werebasedon different sample sizes(number and size ofundertakings)in different Member States.Thefinal calibrationwasbasedon the analysisof larger sampleof data.It is important to note that the resultsare not far different from thoseproduced by other analyses.Solvency ii Associationwww.solvency-ii-association.com
  61. P a g e | 61EIOPAPublic consultation on Guidelinesrelated to thepreparation for Solvency IIThe European Insurance and Occupational PensionsAuthority (EIOPA) launched a public consultation onGuidelinesrelated tothepreparationfor Solvency II.Thepurposeof theGuidelinesis tosupport bothNational Competent Authorities(NCA‘s) andundertakingsin their preparation for theSolvency IIrequirements.TheGuidelinescover the areasthat EIOPAconsiders fundamental toensure effectivepreparationfor SolvencyII: system of governance,includingrisk management; forwardlookingassessment of theundertaking‘sownrisk(based on the OwnRisk and SolvencyAssessment (ORSA) principles);submission of informationtoNationalCompetent Authorities(NCA‘s); pre-applicationof internal models.It is up to NCAs to determine how to comply with EIOPA‘s Guidelinesby incorporating them into their regulatory or supervisory framework inan appropriatemanner.NCAs are expected toensure that insurancecompanies and groupstakeactivestepstowardsimplementingthe relevant aspectsof theregulatoryframeworkaddressed in theseGuidelines,sothat when SolvencyII isapplicable, itsrequirementscan be fullycomplied with.However, EIOPA makes it clear that the Guidelines should be applied ina proportionate way and in particular with regard to the burden on smallandmedium size undertakings.Thepublic consultation will end on 19 June 2013.EIOPA intendsto subsequentlypublish thefinal Guidelinesin theautumnof this year.Solvency ii Associationwww.solvency-ii-association.com
  62. P a g e | 62This should allowNCAs toput in placecertain important aspectsof thepreparation for SolvencyII startingon 1January2014.Consultation Paper on the Proposal for Guidelineson the System of Governance1.GuidelinesIntroduction1.According toArticle 16of Regulation (EU) 1094/2010of 24November2010(hereafter, EIOPARegulation or theRegulation) EIOPA is issuingGuidelinesaddressed tonational competent authoritieson how toproceedin the preparatory phaseleadingup totheapplicationsofDirective2009/138/EC of the European Parliament and of the Council of25November 2009on the taking-upand pursuit of thebusinessofInsuranceand Reinsurance(SolvencyII)3.2. TheseGuidelinesare based onArticles40to49,Article 93,Article132andArticle 246of SolvencyII.3.In the absenceof a political agreement on OmnibusII, Europeannational competent authoritiesmay be forcedtodevelop nationalsolutionsin order toensure sound risksensitivesupervision.Insteadof reachingconsistent and convergent supervisionin the EU,different national solutionsmay emergetothedetriment of a goodfunctioninginternalmarket.4.It is of keyimportancethat there will be a consistent and convergentapproachwith respect to the preparation of SolvencyII.These Guidelines should be seen as preparatory work for Solvency II byfostering preparation with respect to key areas of Solvency II in order toensure proper management of undertakingsand to ensurethatSolvency ii Associationwww.solvency-ii-association.com
  63. P a g e | 63supervisorshave sufficient information at hand.Theseareasare thesystem of governance, includingrisk managementsystem and a forwardlookingassessment of the undertakingsownrisks(based on the OwnRisk and SolvencyAssessment principles, knownasORSA), pre-application for internal models, and submission ofinformation to national competent authorities.5.Early preparation is a key in order to ensure that when Solvency II isfully applicable undertakings and national competent authorities will bewell prepared and ableto applythenew system.For this, national competent authoritiesare expected to engagewithundertakingsin a closedialogue.6.As part of the preparation for the implementationof SolvencyII, national competent authoritiesshould put in place from 1January2014the Guidelinesasset out in thisdocument sothat insuranceandreinsuranceundertakingstaketheappropriate steps.7.National competent authoritiesshould sendto EIOPA, a progressreport on theapplicationof theseGuidelinesby the end of Februaryfollowingeach relevant year, the first beingby 28 February 2015basedontheperiod 1January 2014to 31December 2014.8.TheseGuidelinesincludeGuidelineson the prudent personprinciple.National competent authoritiesare expectedtoensure that undertakingsduring thepreparatory period alreadytakeintoaccount thisprincipleontop of thesystem of regulatoryquantitativelimitsapplicableunder thecurrent supervisoryregime.In additionnational competent authoritiesare expectedtoensure thatprogressis made byundertakingsto makethe necessarytransitionovertheduration of the interim period towardshaving all therequisiteSolvency ii Associationwww.solvency-ii-association.com
  64. P a g e | 64governancesurroundinginvestmentsin place.This doesnot implythat undertakings‘investment portfoliosalreadyhavetobe changed totheextent undertakingswouldconsider necessarywhentheSolvencyII regimeis fullyapplicable.9.TheGuidelinesconcerningthe actuarial function contain referencestocapital requirementsand technical provisions.Thesereferencesareto be understood asreferencesto SolvencyIIrequirements.Amajorityof the tasksof theactuarial function concernsthecoordinationof SolvencyII technical provisions.During the preparatory period these tasks are mainly relevant withregard to the submission of interim information to the supervisoryauthority.There is no full framework for technicalprovisionsvaluation during thisperiod.For thepurposeof thepreparatory reportingand onlyfor that purposetheframeworkwill be provided later.10.National competent authoritiesare expected to ensure that theseGuidelinesare appliedin a manner whichis proportionateto thenature,scaleand complexityof therisksinherent in the businessof theinsuranceand reinsuranceundertaking.TheGuidelinesalreadyreflect the application of the principlesofproportionalityby havingthe principleembedded.11.Thenational competent authoritiesshould applytheGuidelinestoboth individual undertakingsand mutatis mutandis at thelevel of thegroup. Additionally, for groupsnational competent authoritiesneed toSolvency ii Associationwww.solvency-ii-association.com
  65. P a g e | 65applythe group specific Guidelines.12.TheGuidelinesshall apply from 1of January 2014.Section I: General Provisions for preparatory GuidelinesGuideline 1- General provisions for Guidelines13.National competent authoritiesshould takethe appropriate stepsinorder to put in place from 1January2014thepresent GuidelinesonSystem of Governance.14.National competent authoritiesshould ensurethat insuranceandreinsuranceundertakingsand groupstake the appropriate stepsto:a.build an effectivesystem of governanceaccordingtothe SolvencyIIDirectivewhichprovidesfor sound and prudent management;b.build an effectiverisk-management system comprisingstrategies,processesand reportingproceduresnecessarytoidentify, measure,monitor, manage and report, on a continuousbasisthe risks,at anindividual and at anaggregated level, to whichtheyare or could beexposed, and their interdependencies;andc.build qualitativeinformation supportingthe system of governance thatwill allownational competent authoritiesto review and evaluatethequalityof theinformation.Guideline 2 - Progress report to EIOPA1.15.National competent authoritiesshould send toEIOPA, a progressreport on theapplicationof theseGuidelinesby theend of Februaryfollowingeach relevant year, the first beingby 28 February 2015basedontheperiod 1January 2014to 31December 2014.Solvency ii Associationwww.solvency-ii-association.com
  66. P a g e | 66Section II: System of GovernanceChapter I: General governance requirementsGuideline 3 - The administrative, management or supervisorybody (AMSB)16.In accordancewithArticle 41of SolvencyII, national competentauthoritiesshould ensure that the administrative, management orsupervisorybody of theundertaking hasappropriateinteractionwithanycommitteeit establishesaswell aswithsenior management and withother key functionsin theundertaking, requestinginformation from themproactivelyand challengingthat information whennecessary.17.In accordancewithArticle 246of SolvencyII, national competentauthoritiesshould ensure that at group level, the administrative,management or supervisorybody of theentityresponsiblefor fulfillingthegovernance requirementshasan appropriateinteractionwith theadministrative,management or supervisorybodies of all entitieswithinthegroup, requestinginformation proactively in the mattersthat mayaffect thegroup and challengingthe decisionmaking both at group andentitylevel.Guideline 4 – Organisational and operational structure18.In accordancewithArticle 41of SolvencyII, national competentauthoritiesshould ensure that the undertakinghasorganisational andoperational structuresaimedat supportingthe strategicobjectivesandoperationsof the undertaking.Such structures should be able to be adapted to changes in the strategicobjectives, operations or in the business environment of the undertakingwithin an appropriate period of time.19. In accordancewithArticle 246of SolvencyII, national competentSolvency ii Associationwww.solvency-ii-association.com
  67. P a g e | 67authoritiesshould ensure that the administrative, management orsupervisorybody of theentityresponsiblefor fulfillingthe governancerequirementsat group level assesseshow changestothe group‘sstructure impact on thesoundnessof theundertakingand makesthenecessaryadjustmentsin a timelymanner.20.In accordancewithArticle 246of SolvencyII, national competentauthoritiesshould ensure that, in order totake appropriatemeasures,theadministrative,management or supervisorybody of theentityresponsiblefor fulfilling the governancerequirementsat group level knowsthecorporateorganisationof the group, the purposeof itsdifferent entitiesand the linksand relationshipsbetweenthem aswellaskeepitselfinformedabout the risksarising from thegroup‘sstructure.Guideline 5 - Key functions21.In accordancewithArticles 44, 46, 47 and 48 of SolvencyII, nationalcompetent authoritiesshould ensurethat the undertakingappropriatelyimplementsthefollowingkeyfunctions:risk managementfunction, compliancefunction, internal audit function and actuarialfunction.22.In accordancewithArticles 44, 46, 47and 48of SolvencyII, nationalcompetent authoritiesshould ensurethat the entityresponsibleforfulfillingthe governancerequirementsat group level appropriatelyimplementsthefollowingkeyfunctions:risk managementfunction, compliancefunction, internal audit function and actuarialfunction at thelevel of the group.Guideline 6 – Decision-making23.In accordancewithArticle 41of SolvencyII, national competentauthoritiesshould ensure that the undertakingensuresthat at leasttwopersonseffectivelyrun theundertaking.That impliesthat anysignificant decision of the undertakinginvolvesatleast twopersonswhoeffectively run theundertakingbeforethe decisionSolvency ii Associationwww.solvency-ii-association.com
  68. P a g e | 68is beingimplemented.Guideline 7 - Documentation of decisions taken at the level ofthe AMSB24.In accordancewithArticle 41of SolvencyII, national competentauthoritiesshould ensure that theundertakingappropriatelydocumentsthedecisionstaken at thelevel of theadministrative,management orsupervisorybody of theundertaking and how information from the riskmanagement system hasbeen taken intoaccount.Guideline 8 - Internal review of the system of governance25.In accordancewithArticle 41of SolvencyII, national competentauthoritiesshould ensure that the administrative, management orsupervisorybody of theundertaking determinesthescope andfrequencyof the internal reviewsof thesystem of governance, takingintoaccount thenature, scaleand complexityof thebusinessboth atindividual and at group level, aswell asthestructure of thegroup.26.In accordancewithArticle 41of SolvencyII, national competentauthoritiesshould ensure that it is up tothe undertaking to decidewhois toperform the reviewswithin the undertaking.27.In accordancewithArticle 41of SolvencyII, national competentauthoritiesshould ensure that the scope, findingsand conclusionsof thereview are properlydocumented and reported tothe administrative,management or supervisorybody of theundertaking.Suitablefeedback loopsare necessarytoensure follow-upactionsareundertaken and recorded.Guideline 9 – Policies28.In accordancewithArticle 41of SolvencyII, national competentauthoritiesshould ensure that the undertakingalignsall policiesSolvency ii Associationwww.solvency-ii-association.com
  69. P a g e | 69requiredaspart of the system of governancewitheach other and withitsbusinessstrategy.Thepoliciesshould clearlyset out at least:a)thegoalspursued by the policy;b) thetaskstobe performed and thepersonor role responsiblefor them;c) theprocessesand reporting procedurestobe applied; andd)theobligation of the relevant organisational unitstoinform the riskmanagement, internal audit and the complianceand actuarial functionsof anyfactsrelevant for the performanceof their duties.29.In accordancewithArticle 41of SolvencyII, national competentauthoritiesshould ensure that in thepoliciesthat cover thekeyfunctions,theundertakingalsoaddressesthe position of thesefunctionswithin theundertaking, their rightsand powers.Guideline 10- Contingency plans30.In accordancewithArticle 41of SolvencyII, national competentauthoritiesshould ensure that the undertakingidentifiesrisksto beaddressedby contingencyplansbasedon the areaswhereit considersitselfto be especiallyvulnerableand reviews, updatesand teststhesecontingencyplanson a regular basis.Chapter II: Fit and Proper Guideline – Fit requirements31.In accordancewithArticle 42 of SolvencyII, national competentauthoritiesshould ensure that personswhoeffectivelyrun theundertakingor haveother key functions, includingmembersof theadministrative,supervisoryor management body of the undertaking arefit and takeaccount of the respectivedutiesallocatedtoindividualmembersto ensure appropriatediversity of qualifications,knowledgeSolvency ii Associationwww.solvency-ii-association.com
  70. P a g e | 70and relevant experiencetoensurethat theundertakingismanaged andoverseenin a professional manner.1.32.In accordancewithArticle 42of SolvencyII, national competentauthoritiesshould ensure that the undertakingensuresthat the membersof the administrative, management or supervisorybody collectivelypossessat least qualification, experienceand knowledgeabout:a) insuranceand financial markets;b) businessstrategyand businessmodel;c) system of governance;d) financial and actuarial analysis; ande) regulatoryframework and requirements.Guideline 12- Proper requirements33.In accordancewithArticle 42of SolvencyII, national competentauthoritiesshould ensure that the undertaking, whenassessingwhetheraperson is proper, includesan assessment of that persons honesty andfinancial soundnessbased on relevant evidenceregardingtheir character,personal behaviour and businessconduct includingany criminal,financial, supervisory aspectsregardlessof location.Theperiod of limitation of thecommitted offenceis judgedbased onnational law or practice.34.In accordancewithArticle 41and 42 of SolvencyII, nationalcompetent authoritiesshould ensurethat the undertakinghasa policyon the fit and proper requirements,whichincludesat least:a) a description of theprocedure for assessingthe fitnessand proprietyof the personswhoeffectivelyrun the undertakingor have other keyfunctions,both when beingconsidered for the specific positionand onSolvency ii Associationwww.solvency-ii-association.com
  71. P a g e | 71an on-goingbasis;b)a description of the situationsthat give rise toa re-assessment of thefit and proper requirements;andc)a description of the procedure for assessingthe fit and properrequirementsof other relevant personnel not subject tothe requirementsofArticle 42 of Solvency II accordingto internal standards, both whenbeingconsidered for the specific positionand on an on-going basis.Guideline 14- Outsourcing of key functions35.In accordancewithArticle 42and 49 of Solvency II, nationalcompetent authoritiesshould ensurethat the undertakingapplies the fitandproper requirementsto thepersonsemployed by the serviceprovideror sub service provider toperform an outsourcedkey function.36.In accordancewithArticle 42and 49 of Solvency II, nationalcompetent authoritiesshould ensurethat the undertakingdesignatesaperson within theundertakingwith overall responsibilityfor theoutsourced keyfunction whoisfit and proper and possessessufficientknowledgeand experienceregardingtheoutsourced keyfunction to beableto challengetheperformanceand resultsof the service provider.Chapter III: Risk Management Guideline 15- Role of theadministrative, management or supervisory body in the riskmanagement system37.In accordancewithArticle 44of SolvencyII, national competentauthoritiesshould ensure that the administrative, management orsupervisorybody of theundertaking is ultimately responsibleforensuring the effectivenessof the risk management system, settingtheundertaking‘srisk appetiteand overall risk tolerancelimitsaswell asapprovingthe mainrisk management strategiesand policies.38. In accordancewithArticle 246of SolvencyII, national competentSolvency ii Associationwww.solvency-ii-association.com
  72. P a g e | 72authoritiesshould ensure that the administrative, management orsupervisorybody of theentityresponsiblefor fulfillingthe governancerequirementsat group level is responsiblefor the effectivenessof the riskmanagement system of thewholegroup.This risk management system should includeat least:a)thestrategic decisionsand policieson risk management at grouplevel;b)thedefinition of group‘sriskappetiteand overall risk tolerancelimits;andc)theidentification, measurement, management and control of risks atgroup level.39.In accordancewithArticle 246of SolvencyII, national competentauthoritiesshould ensure that the entityresponsiblefor fulfillingthegovernancerequirementsat group level ensuresthat such strategicdecisionsand policiesare consistent withthe group‘s structure, size andthespecificitiesof theentitiesin thegroup and that thespecificoperationsand associatedrisksof each entity in the group are coveredand in addition, it ensuresthat an integrated, consistent and efficient riskmanagement of thegroup isput in place.Guideline 16- Risk management policy40.In accordancewithArticle 44of SolvencyII, national competentauthoritiesshould ensure that the undertakingestablishesa riskmanagement policy whichat least:a)definestherisk categoriesand the methodsto measuretherisks;b)outlineshow theundertakingmanageseach relevant categoryandarea of risks;Solvency ii Associationwww.solvency-ii-association.com
  73. P a g e | 73c)describesthe connectionwiththe overall solvencyneedsassessment asidentified in the forwardlookingassessment of the undertaking‘sownrisks(basedon theORSAprinciples), the regulatory capital requirementsand the undertaking‘srisk tolerancelimits;d)specifies risktolerance limitswithinall relevant risk categoriesin linewith the undertaking‘soverall risk appetite;ande)setsout thefrequencyand content of regular stresstests,and describethesituationsthat wouldwarrant special stresstests.Guideline 17- Risk management function: general tasks41.In accordancewithArticle 44 of SolvencyII, national competentauthoritiesshould ensure that the undertakingrequires the riskmanagement function to report to the administrative, management orsupervisorybody on risksthat have been identifiedaspotentiallymaterial.Therisk management function should alsoreport on other specific areasof risks both on itsowninitiativeand followingrequestsfrom theadministrative,management or supervisorybody.42.In accordancewithArticle 246of SolvencyII, national competentauthoritiesshould ensure that the entityresponsiblefor fulfillingthegovernancerequirementsat group level ensuresthat the risk policy isimplementedconsistentlyacrossthe group.Guideline 18- Underwriting and reserving risk43.In accordancewithArticle 44of SolvencyII, national competentauthoritiesshould ensure that in itsrisk management policy, theundertakingcoversat least the followingwithregard to underwritingandreservingrisk:a) the typesand characteristicsof theinsurancebusiness, for example,thetype of insurancerisk the undertakingis willingto accept;Solvency ii Associationwww.solvency-ii-association.com
  74. P a g e | 74b)how the adequacyof premium incometo cover expectedclaims andexpensesis tobe ensured;c)theidentificationof the risksarising from the undertaking‘sinsuranceobligations,includingembedded optionsand guaranteed surrendervaluesin itsproducts;d)how, in the design of a new insuranceproduct and the premiumcalculation, the undertakingtakesaccount of the constraintsrelatedtoinvestments;ande)how, in the design of a new insuranceproduct and the premiumcalculation, the undertakingtakesaccount of reinsurance or other riskmitigation techniques.Guideline 19– Operational risk1.44.In accordancewithArticle 44of SolvencyII, national competentauthoritiesshould ensure that in therisk management policy, theundertakingcoversat least the followingwithregard to operational risk:a)identificationof the operational risksit is or might be exposed toandthewaytomitigatethem;b)activitiesand internal processesin placein theundertaking, includingtheIT system supportingthem; andc)risk tolerancelimitswithrespect to the undertaking‗skey operationalrisk areas.1.45.In accordancewithArticle 44of SolvencyII, national competentauthoritiesshould ensure that the undertakinghasprocessesto identify,analyseand report on operational risk events.For this purpose, it should set up a system for collectingand monitoringoperational risk events.Solvency ii Associationwww.solvency-ii-association.com
  75. P a g e | 751.46.In accordancewithArticle 44of SolvencyII, national competentauthoritiesshould ensure that for thepurposesof operational riskmanagement, theundertakingdevelops and analysesan appropriatesetof operational riskstressscenariosbased on at least thefollowingapproaches:a) thefailure of a key process, personnel or system; andb) theoccurrenceof external events.Guideline 20 – Control and documentation of risk-mitigation47.In accordancewithArticle 44 of SolvencyII, national competentauthoritiesshould ensure that for thepurposesof proper useofreinsuranceand other risk mitigationtechniquesthe undertakinganalyses, assessesand documentsthe effectivenessof all risk mitigationtechniquesemployed.Guideline 21- Reinsurance and other risk-mitigationtechniques– risk management policy48.In accordancewithArticle 44of SolvencyII, national competentauthoritiesshould ensure that in the risk management policy theundertakingcoversat least the followingwithregard to reinsuranceandother risk mitigationtechniques:a)identificationof the level of risk transfer appropriatetotheundertaking‘sdefined risk limitsand whichkind of reinsurancearrangementsare most appropriateconsideringthe undertaking‘sriskprofile;b)principlesfor the selection of reinsurancecounterpartiesandproceduresfor assessingand monitoringthe creditworthinessanddiversification of reinsurancecounterparties;c) proceduresfor assessingtheeffectiverisk transfer and considerationSolvency ii Associationwww.solvency-ii-association.com
  76. P a g e | 76of basisrisk;d)liquiditymanagement todeal withanytimingmismatch betweenclaims‘paymentsand reinsurancerecoveries;ande)whereapplicable,proceduresfor ensuringthat unit-linkedpolicyholders continueto receivebenefitsin linewithaimsandobjectivesoriginallycommunicated to them.Guideline 22 - Asset-liability management1.49.In accordancewithArticle 44of SolvencyII, national competentauthoritiesshould ensure that in itsrisk management policy theundertakingcoversat least the followinginformationwithregard toasset-liability management:a)a description of theprocedure for identificationand assessment ofdifferent naturesof mismatchesbetweenassetsand liabilities,at leastwith regard totermsand currency;b)a description of mitigationtechniquestobe used and theexpectedeffect of relevant risk-mitigatingtechniqueson asset-liabilitymanagement;c)a description of deliberatemismatchespermitted and thecontent andfrequencyof stress-teststo be conducted and monitored; andd)a description of the underlying methodologyand frequencyof stresstestsand scenario teststobe carried out.Guideline 23 - Investment risk1.50.In accordancewithArticles 44 and 132of Solvency II, nationalcompetent authoritiesshould ensurethat in itsrisk managementpolicy, theundertaking coversat least the followingwith regard toinvestments:Solvency ii Associationwww.solvency-ii-association.com
  77. P a g e | 77a)thelevel of security, quality, liquidity, profitabilityand availability theundertakingisaimingfor with regard tothewholeportfolio of assetsandhowit plansto achievethis;b)theinternal quantitativelimitson assetsand exposures,includingoff-balancesheet exposures,that are to be establishedtohelp theundertakingachieveits desired level of security, quality, liquidity,profitabilityand availability for the portfolio;c) considerationof the financial market environment;d) theconditionsunder whichthe undertakingcan pledgeor lend assets;e)thelink betweenmarket riskand other risksin highly adversescenarios;f)theprocedure for appropriatelyvaluingand verifying the investmentassets;g)theproceduresto monitor theperformanceand review thepolicywhennecessary; andh)how the assetsare to be selected in thebest interest of policyholdersandbeneficiaries.Guideline 24 - Liquidity risk1.51.In accordancewithArticle 44of SolvencyII, national competentauthoritiesshould ensure that in itsrisk management policy, theundertakingcoversat least the followingitemswithregard to liquidityrisk:a) the procedurefor determining the level of mismatchbetweenthe cashinflowsand thecash outflowsof both assetsand liabilities,includingexpectedcash flowsof direct insuranceand reinsurancesuch asclaims,lapsesor surrenders;Solvency ii Associationwww.solvency-ii-association.com
  78. P a g e | 78b)considerationof total liquidityneedsin the short and medium termincludingan appropriate liquiditybuffer toguard against a liquidityshortfall;c)considerationof the level and monitoring of liquidassets, includingaquantification of potential costsor financial lossesarisingfrom anenforced realisation;d)considerationof the identificationand costof alternativefinancingtools; ande)considerationof the effect on the liquiditysituation of expectednewbusiness.Chapter IV: The ―prudent person‖ principle and the system ofgovernance Guideline 25 - Investment risk management52.In accordancewithArticle 132of Solvency II, national competentauthoritiesshould ensure that for thepurposeof the investment riskmanagement the undertakingdevelops itsown set of keyrisk indicatorsadaptedto itsriskmanagement policyand businessstrategy.53.In accordancewithArticle 132of Solvency II, national competentauthoritiesshould ensure that the undertakingdoesnot solelydepend ontheinformation provided by financial institutions,asset managersandratingagencies.In making its investment decisions,theundertakingshould take intoaccount the risksassociatedwith theinvestmentswithout relying onlyon the risk beingadequatelycaptured by the capital requirements.Guideline 26 –Assessment of non-routine investment activities54.In accordancewithArticle 132of Solvency II, national competentauthoritiesshould ensure that beforeperforming any investment orinvestment activityof a non-routinenature the undertaking carries outSolvency ii Associationwww.solvency-ii-association.com
  79. P a g e | 79an assessment of at least:a)itsabilitytoperform and manage the investment or the investmentactivity;b)therisksspecificallyrelated tothe investment or the investmentactivityand the impact of theinvestment or the investment activityontheundertaking‘srisk profile;c)theconsistencyof theinvestment or investment activity withthebeneficiariesand policyholder‘sinterest, liability constraintsset by theundertakingand efficient portfolio management; andd)theimpact of thisinvestment or investment activityon thequality,security, liquidity, profitability and availability of the wholeportfolio.55.In accordancewithArticle 132of Solvency II, national competentauthoritiesshould ensure that wheretheinvestment or investmentactivityentails a significant riskor changein the risk profile, theundertaking‘srisk management function communicatessucha risk orchangein the risk profile tothe administrative, management orsupervisorybody of theundertaking.Guideline 27 - Unit-linked and index-linked contracts56.In accordancewithArticles 44 and 132of Solvency II, nationalcompetent authoritiesshould ensurethat the investmentsof unit-linkedand index-linkedcontractsof theundertakingare selected in thebestinterest of policyholders and beneficiariestaking intoaccount anydisclosedpolicyobjectives.57.In accordancewithArticles 44 and 132of Solvency II, nationalcompetent authoritiesshould ensurethat, in thecaseof unit-linkedbusiness,theundertakingtakesintoaccount and managethe constraintsrelatedtounit-linkedcontracts,in particular liquidityconstraints.Solvency ii Associationwww.solvency-ii-association.com
  80. P a g e | 80Guideline 28 - Assets not admitted for trading on a regulatedfinancial market58.In accordancewithArticles 44 and 132of Solvency II, nationalcompetent authoritiesshould ensurethat the undertakingimplements,manages,monitorsand controlsproceduresin relationtoinvestmentsthat are not admitted to tradingon a regulated financialmarket or to complex products, whicharedifficult tovalue.59.In accordancewithArticles 44 and 132of Solvency II, nationalcompetent authoritiesshould ensure that the undertakingtreats assetsadmittedto trading, but not traded or traded on a non-regularbasis, similarlyto thoseassetsnot admitted totradingon a regulatedfinancial market.Guideline 29 - Derivatives60.In accordancewithArticles44and 132of Solvency II, nationalcompetent authoritiesshould ensurethat the undertaking, whenit usesderivatives,implementsthe proceduresin linewithitsrisk managementpolicy on investmentstomonitor theperformanceof thesederivatives.61.In accordancewithArticles 44 and 132of Solvency II, nationalcompetent authoritiesshould ensurethat the undertakingdemonstrateshow thequality, security, liquidityor profitability of the wholeportfolio isimproved without significant impairment of any of thesefeatureswherederivativesare used tofacilitateefficient portfolio management.62.In accordancewithArticles 44 and 132of Solvency II, nationalcompetent authoritiesshould ensurethat the undertakingdocumentstherationaleand demonstratestheeffectiverisk transferobtained by theuseof the derivativeswherederivativesare usedtocontributetoa reductionof risks or asa risk mitigationtechnique.Solvency ii Associationwww.solvency-ii-association.com
  81. P a g e | 81Guideline 30 - Securitised instruments63.In accordancewithArticles44and 132of Solvency II, nationalcompetent authoritiesshould ensurethat, wheretheundertakinginvestsin securitisedinstruments,it ensuresthat its interestsand the interestsoftheoriginator concerningthesecuritisedassetsare well understoodandaligned.Chapter V: Own fund requirementsand the system ofgovernanceGuideline 31– Capital Management Policy64.In accordancewithArticle 41and 93 of SolvencyII, nationalcompetent authoritiesshould ensurethat the undertakingshould bedeveloping a capital management policy which includes:a.a description of the procedure to ensure that own fund items, both atissue and subsequently, meet the requirements of the applicable capitaland distribution regime and are classified correctly where the applicableregimerequires;b.a description of the procedure tomonitor theissuanceof ownfunditemsaccordingto themedium term capital management plan;c.a description of theprocedure to ensure that thetermsand conditionsof anyown fund item are clear and unambiguousin relation to thecriteria of the applicablecapital regime;andd. a description of the procedurestoi. ensurethat any policy or statement in respect of ordinarysharedividendsis taken intoaccount in considerationof thecapital position;andSolvency ii Associationwww.solvency-ii-association.com
  82. P a g e | 82ii. process to be conducted to identify, document and action instances inwhich distributions on an own funds item are expected to be deferred orcancelled.Guideline 32 – Medium-term Capital Management Plan1.65.In accordancewithArticle 41and 93 of Solvency II, nationalcompetent authoritiesshould ensurethat the undertakingis developinga medium-term capital management plan whichisto be monitoredbytheadministrative, management or supervisorybody of theundertakingand which includesat leastconsiderationsof:a.any planned capital issuance;b.thematurity, incorporatingboth the contractual maturityand anyearlier opportunitytorepay or redeem, relatingtothe undertaking‘sownfund items;c.how any issuance,redemption or repayment of, or other variation inthevaluation of, an ownfundsitem affectsthe application of anylimitsin theapplicablecapital regime; andd. theapplicationof the distributionspolicy.66.In accordancewithArticle 41and 93 of SolvencyII, nationalcompetent authoritiesshould ensurethat the undertakingtakesintoaccount in thecapital management plan the output from the riskmanagement systemsand the forwardlookingassessment of theundertaking‘sownrisks(basedon theORSAprinciples).Chapter VI: Internal ControlsGuideline 33 – Internal Control environment67.In accordancewithArticle 46of SolvencyII, national competentauthoritiesshould ensure that the undertakingpromotestheimportanceSolvency ii Associationwww.solvency-ii-association.com
  83. P a g e | 83of performing appropriate internal controlsby ensuring that allpersonnel are awareof their role in the internal control system.Thecontrol activitiesshould be commensuratetotherisks arisingfromtheactivitiesand processestobe controlled.68.In accordancetoArticle246of SolvencyII, national competentauthoritiesshould ensure that the entityresponsiblefor fulfillingthegovernancerequirementsat group level ensuresa consistentimplementationof theinternal control systemsacrossthe group.Guideline 34 – Monitoring and reporting69.In accordancewithArticle 46of SolvencyII, national competentauthoritiesshould ensure that the monitoring and reportingmechanismswithin theinternal control system of the undertakingprovide theadministrative,management or supervisorybody withtherelevantinformation for thedecision-makingprocesses.Chapter VII: Internal audit function Guideline 35 –Independence70.In accordancewithArticle 47of SolvencyII, national competentauthoritiesshould ensure that whenperforming an audit and whenevaluatingand reporting the audit results, the internal audit function oftheundertakingis not subject to instructionsfrom the administrative,management or supervisorybodythat can impair itsindependenceandimpartiality.Guideline 36 - Internal audit policy71.In accordancewithArticles 41and 47 of SolvencyII, nationalcompetent authoritiesshould ensurethat the undertakinghasan internalaudit policy whichcoversat least thefollowingareas:Solvency ii Associationwww.solvency-ii-association.com
  84. P a g e | 84a.thetermsand conditionsaccordingto whichthe internal auditfunctioncan be called upon togive itsopinion or assistanceor tocarryout other special tasks;b.internal rulessetting out the proceduresthe person responsiblefor theinternalaudit function needsto followbeforeinformingthesupervisoryauthority; andc. thecriteria for therotation of staff assignments.1.72.In accordancewithArticles 41and 246of SolvencyII, nationalcompetent authoritiesshould ensurethat the entityresponsibleforfulfillingthe governancerequirementsat group level ensuresthat theaudit policy at the level of the group demonstratesthat the internalauditfunctionis ableto:a.coordinatetheinternal audit activityacrossthe group; andb.ensure compliancewith the internal audit requirementsat the grouplevel.Guideline 37 – Internal audit plan1.73.In accordancewithArticle 47of SolvencyII, national competentauthoritiesshould ensure that the internal audit function of theundertaking:a.establishes,implementsand maintainsan audit plan setting out theaudit worktobe undertakenin theupcoming years, takingintoaccountall activitiesand thecompletesystem of governanceof the undertaking;b. takes a risk-basedapproach in decidingits priorities;c.reportsthe audit plan tothe administrative, management orsupervisorybody;Solvency ii Associationwww.solvency-ii-association.com
  85. P a g e | 85d.issuesrecommendationsbased on theresult of workcarried out inaccordancewithpoint (a) and submit a writtenreport on itsfindingsandrecommendationstotheadministrative, management or supervisorybodyon at least an annual basis;ande.verifies compliancewiththe decisionstaken by the administrative,management or supervisorybody on thebasisof thoserecommendationsreferredto in point (d).74.In accordancewithArticle 47of SolvencyII, national competentauthoritiesshould ensure that wherenecessary, the internal auditfunctionmay carryout auditswhicharenot included in theaudit plan.Guideline 38 - Internal audit findings and recommendations75.In accordancewithArticle 47of SolvencyII, national competentauthoritiesshould ensure that the recommendationsof the internal auditfunctionof the undertaking includesthe envisaged period of time toremedytheshortcomingsand the personsresponsiblefor doingso.Guideline 39 – Internal audit report for the administrative,management or supervisory body76.In accordancewithArticle 47of SolvencyII, national competentauthoritiesshould ensure that theinternal audit function of theundertakingissuesat least annuallyan internal audit report totheadministrative,management or supervisorybody.This report should includeinformation on the extent to whichtheinternalaudit function‘sobjectives,the execution of the audit plan andthefollow-up of audit recommendationshavebeen achieved.Solvency ii Associationwww.solvency-ii-association.com
  86. P a g e | 86Chapter VIII: Actuarial Function Guideline 40 - Tasksof theactuarial function77.In accordancewithArticle 48of SolvencyII, national competentauthoritiesshould ensure that the undertakingtakes appropriatemeasuresto addressthepotential conflictsof interests,if theundertakingdecidesto add additional tasksor activitiesto thetasksand activitiesoftheactuarial function.78.In accordancetoArticle246of SolvencyII, thenational competentauthoritiesshould ensure that the entityresponsiblefor fulfillingthegovernancerequirementsat group level requiresthat the actuarialfunctiongivesin additionan opinionon the reinsurancepolicyand thereinsuranceprogram for the group asa whole.Guideline 41- Coordination of the calculation of technicalprovisions79.In accordancewithArticle 48of SolvencyII, national competentauthoritiesshould ensure that the actuarial function of theundertakingidentifiesany inconsistencywiththe requirementsset out in Articles76to85of Solvency II for the calculation of technicalprovisionsandimplementscorrectionsasappropriate.Guideline 42 – Valuation models of technical provisions80.In accordancewithArticle 48of SolvencyII, national competentauthoritiesshould ensure that the actuarial function of theundertakingprovidesthat the keydrivers of the undertaking‘srisksare reflectedandappropriatelyaddressedin the valuation modelsunderlying thecalculationof thetechnical provisions, aswellasin the assumptionsandmethodologiesapplied.81.In accordancewithArticle 48 of SolvencyII, national competentauthoritiesshould ensure that the actuarial function of theundertakingSolvency ii Associationwww.solvency-ii-association.com
  87. P a g e | 87alsoprovidesthat the valuation models are stablewithrespect to smallvariationsintroduced in the parametersof thesevaluationmodels.Guideline 43 – Data quality82.In accordancewithArticle 48of SolvencyII, national competentauthoritiesshould ensure that theactuarial function of theundertakingassessesthe consistencyof the internal and external data used in thecalculationof technicalprovisionsagainstthedata qualitystandardsasset in SolvencyII and that the actuarial function providesrecommendations,whererelevant, on internal procedurestoimprovedata qualitysoasto ensure that theundertaking isa positiontocomplywith the related SolvencyII requirement when implemented.83.In accordancewithArticle 48of SolvencyII, national competentauthoritiesshould ensure that, if there are anydifferencesamongst thetechnicalprovisionsfor different valuation dates,theundertakingensuresthat theactuarial function presentsanexplanationfor thedeviations.Guideline 44 – Testing against experience84.In accordancewithArticle 48of SolvencyII, national competentauthoritiesshould ensure that the actuarial function of theundertakingreportsany material deviationsof actual experiencecompared to theprojectedbest estimate tothe administrative, management orsupervisorybody.Thereport should identify the causesof the deviationsand, whereapplicable, proposeschangesin the assumptionsand modificationsthatmay be applied tothevaluation model in order toimprovethe bestestimatecalculation.Guideline 45 – Underwriting policy and reinsurancearrangementsSolvency ii Associationwww.solvency-ii-association.com
  88. P a g e | 8885.In accordancewithArticle 48of SolvencyII, national competentauthoritiesshould ensure that the actuarial function of theundertakingtakesintoconsideration theinterrelationsbetweenan undertaking‘sreinsurancearrangements,itsunderwritingpolicy and the technicalprovisions.Guideline 46 – The actuarial function of an undertaking with aninternal model under pre-application86.In accordancewithArticle 48of SolvencyII, national competentauthoritiesshould ensure that the actuarial function of an undertakingcontributestospecifying whichrisks are covered by the internal model,whichis the subject of a pre-application, in particular with regard to therisksrelatingto the terms on which businessis writtenand howdependenciesbetweenrisksare derived.This opinion isbased on a technicalanalysisand should reflect theexperienceand expertiseof the function.Guideline 47 - Annual internal report to the administrative,management or supervisory body87.In accordancewithArticle 48 of SolvencyII, national competentauthoritiesshould ensure that the actuarial function of theundertakingproducesa writtenreport to besubmitted to the administrative,management or supervisorybody, at least annually.Thereport should document all tasksthat have been undertaken by theactuarial functionsand their results, and clearlyidentifiesanydeficienciesand givesrecommendationsasto how such deficienciescould be remedied.Solvency ii Associationwww.solvency-ii-association.com
  89. P a g e | 89Chapter IX: Outsourcing Guideline 48 - Critical or importantoperational function88.In accordancewithArticle 49of SolvencyII, national competentauthoritiesshould ensure that the undertakingdeterminesanddocumentswhetherthe outsourcedfunction is a critical or importantfunctionand on the basisof whetherthisfunction is essential to theoperation of the undertakingasit wouldbe unableto deliver itsservicestopolicyholders without the function.Guideline 49 - Underwriting89.In accordancewithArticle 49of SolvencyII, national competentauthoritiesshould ensure that, when aninsuranceintermediary, whoisnot an employee of theundertaking, is given authorityto underwritebusinessor settle claimsin the name and on account of an insuranceundertaking, the undertakingensuresthat the activityof thisintermediary issubject totheoutsourcing requirements.Guideline 50 - Intra-group outsourcing90.In accordancewithArticle 49of SolvencyII, national competentauthoritiesshould ensure that, if keyfunctionsare outsourcedwithinthegroup, the entityresponsiblefor fulfillingthegovernance requirementsatgroup level documentswhichfunctionsrelateto whichlegal entityandensuresthat theperformanceof thekey functionsat thelevel of theundertakingisnot impairedby such arrangements.Guideline 51- Outsourcing written policy91.In accordancewithArticle 49 of SolvencyII, national competentauthoritiesshould ensure that the undertakingthat outsourcesorconsidersoutsourcing coversin itspolicythe undertaking‘sprocessesand strategiesfor outsourcingfrom theinceptiontothe end of thecontract.Solvency ii Associationwww.solvency-ii-association.com
  90. P a g e | 90This in particular includes:a.how a service provider of suitablequalityis selected;b.thedetails tobe included in thewrittenagreement withthe service;andc. businesscontingencyplans,includingexit strategies.Section III: Group governance specific requirementsGuideline 52 - Entity responsible for the fulfilment of the groupgovernance requirements92.In accordancewithArticle 246of SolvencyII, national competentauthoritiesshould ensure that the parent insuranceor reinsuranceundertakingor insuranceholding company identifiesthe undertakingresponsiblefor fulfillingthegovernance requirementsat group level andreport it tothe group supervisor.Guideline 53 - Responsibilities for setting internal governancerequirements93.In accordancewithArticle 246of SolvencyII, national competentauthoritiesshould ensure that the entityresponsiblefor fulfillingthegovernancerequirementsat group level setsadequate internal governancerequirementsacrossthe group appropriateto thestructure, businessandrisksof the group and of itsrelated entities, and considersthe appropriatestructureand organizationfor risk management at group level, settingaclearallocationof responsibilitiesbetweenall entitiesof the group.94.In accordancewithArticle 246of SolvencyII, national competentauthoritiesshould ensure that the entityresponsiblefor fulfillingthegovernancerequirementsat group level doesnot impair theresponsibilitiesof the administrative,management or supervisorybodySolvency ii Associationwww.solvency-ii-association.com
  91. P a g e | 91of each entityin thegroup when settingup itsown system ofgovernance.Guideline 54 – System of Governance at group level1.95.In accordancewithArticle 246of SolvencyII, national competentauthoritiesshould ensure that the entityresponsiblefor fulfillingthegovernancerequirementsat group level:a.hasin placeappropriate and effectivetools,proceduresand linesofresponsibilityand accountabilityenablingit tooversee and steer thefunctioningof the riskmanagement and internal control systemsatindividual level;b.hasin place reporting lineswithin the group and effectivesystems forensuring information flowsin thegroup bottom up and top-down aswell;c.documentsand informsall theentitiesin the insurancegroup about thetoolsused toidentify measure, manage and control all risks to whichthegroup isexposed; andd.takes intoaccount the interestsof all the entitiesbelongingto thegroup and how theseinterestscontributeto the common purposeof thegroup asa wholeover the long term.Guideline 55 - Riskswith significant impact at group level1.96.In accordancewithArticle 246of SolvencyII, national competentauthoritiesshould ensure that theentityresponsiblefor fulfillingthegovernancerequirementsat group level considersin itsthe riskmanagement system the risksboth at individual and group level andtheir interdependencies.In particular thefollowingrisksmay have an impact significantlydifferent at group level :Solvency ii Associationwww.solvency-ii-association.com
  92. P a g e | 92a.contagion risk, reputational risk and risks arisingfrom intra-grouptransactionsand risk concentrationsat the group level;b.interdependenciesbetweenrisksstemmingfrom conducting businessthrough different entitiesand in different jurisdictions;c. risksarising from third-country entities;d. risksarisingfrom non-regulatedentities;ande. risksarising from other regulatedentities.Guideline 56 - Group risk management97.In accordancewithArticle 246of SolvencyII, national competentauthoritiesshould ensure that the entityresponsiblefor fulfillingthegovernancerequirementsat group level supportsin itsrisk managementat the level of the group by appropriateprocessesand procedurestoidentify, measure, manage, monitor and report the risksthat the groupand each individual undertakingare or might be exposedto.98.In accordancewithArticle 246of SolvencyII, national competentauthoritiesshould ensure that the entityresponsiblefor fulfillingthegovernancerequirementsat group level ensuresthat the structure andorganizationof thegroup risk management doesnot impair theundertaking‘slegal abilityto fulfil itslegal, regulatory and contractualobligations.Guideline 57 – Group internal model99.In accordancetoArticles120 to126, 231and 246of SolvencyII,through the pre-applicationprocessfor a group internal model underArticle 231of SolvencyII, national competent authoritiesshould form aview on how all theundertakingsthat wouldusethe group internalmodel for their SCR calculationensure that there would be noconstraintsto complywiththetestsand standardsrequired bySolvencySolvency ii Associationwww.solvency-ii-association.com
  93. P a g e | 93II for internal model use.In particular theyensurethat there wouldbe no constraintsfor anappropriateunderstandingof the group internalmodel asrequired bytheuse test provisions.Compliance and Reporting Rules100.This document containsGuidelinesissued underArticle 16 of theEIOPA Regulation. In accordancewithArticle 16(3) of the EIOPARegulation, Competent Authoritiesshall make every effort tocomplywith guidelinesand recommendations.101.Competent authorities that comply or intend to comply with theseGuidelines should incorporate them into their regulatory or supervisoryframeworkin an appropriatemanner.102.Competent authoritiesshall confirm toEIOPAwhether theycomplyor intend tocomply withtheseGuidelines,with reasonsfor non-compliance, by [dd mm yyyy].103.In theabsenceof a responseby thisdeadline,competentauthoritieswill be consideredasnon-compliant tothe reporting.Solvency ii Associationwww.solvency-ii-association.com
  94. P a g e | 94Joint CommitteeReport onRisks andVulnerabilitiesin the EU Financial SystemExecutive SummaryTheEuropean financial system continuesto face a dauntingrange ofinterrelatedrisks, necessitatinga concerted responseby policymakersboth at the political level and from the European System of FinancialSupervision, includingthe European SupervisoryAuthorities(ESAs), inorder to restore the confidenceand trust that hasbeen erodedduringrecent years‘financial crisis.Compared withtheSeptember 2012report, near-term risksto the EUfinancial system from theeuro area debt crisis(especiallybank funding)havegenerallyabated withimproving market confidence.However, financial institutions,in particularbanks, remain vulnerabletoa sudden switchin sentiment.There have also been delays to some of the key policy responses (e.g.Solvency II, CRD IV) which may exacerbate some of the longer termriskshighlightedin thisreport.Many of the risksarisefrom the still weak EU macro-economicoutlook,whichaffectsthe financial positionsof governmentsand private sectorborrowersand theoutlook for propertymarkets,and whichmay lead tofurther deteriorationin the profitability and asset qualityof banks,insurersand other financial market participants.Policy announcementsby European leaders– especiallyon OutrightMonetaryTransactions(OMT) and theSingleSupervisoryMechanismSolvency ii Associationwww.solvency-ii-association.com
  95. P a g e | 95(SSM) – have significantlyreduced market perceptionsof tail risksandledto a narrowingof bank and sovereign credit spreads.But totruly break the bank-sovereignlink and create foundationsforsustainablemacro-economicgrowthwill require continuedprogressonimplementationof announced policies.Financial regulations(includingSolvencyII and CRR /CRD-IV) mustremain economicallyand actuariallysound topromote a stablefinancialsystem that can sustainablyprovidefinancial servicestotherealeconomyand view risksconsistentlyacrossbalancesheets.Low interest ratesare an essential macro-financial policy response,butcan over a longer period of time havevariousnegative side-effects:Solvencypressureson insurersand defined-benefit pension fundsfromhigher present valueof long-term liabilitiesand depressed reinvestmentreturns,incentivesfor searchfor yield behaviour by institutionalinvestors,profitabilitypressureson bank net interest marginsand riskofhidden forbearance, with build-up of latent credit risk and inefficientmarket allocationof credit resources.Financial regulationand supervision need to ensure that, consistentlyacrossthe EU, financial institutionsfullyrecognizeand managetheserisksto ensure resilienceagainstthe risksboth of a prolonged periodoflowinterest ratesand of any sharp adjustment to interest rates.Thecontinueddelayof SolvencyII representsa particular challengeforachievingthis in theinsurance sector.Risksof further fragmentation of the EU SingleMarket havebeenevident through increased home bias and reduced cross-border financialactivityof financial institutions.This trend hasbeendriven mainlyby financial institutions‘revisedbusinessstrategies(e.g. focuson corebusinesses),changesin riskappetite,higher fundingcostsand thechallengingmacro environment.Solvency ii Associationwww.solvency-ii-association.com
  96. P a g e | 96But it hasalsobeenexacerbated by uncoordinatednational policymeasures,includingring-fencing of local bank capital and liquidity,whichhindersthe free movement of capital, increasesfundingcosts,signals supervisorydivergenceand risksfurthersafeguard measures.Market clusteringis alsoevident in securitiesmarkets,withdivergingequityreturns and credit spreadsincreasinglycorrelated withincountriesor country groupsrather than acrosstheEU.For theinsurancesector, progresson supervisoryconvergenceand theSingleMarket remainsstalledduetofragmented national solvencystandardsand delaysto SolvencyII.Tohalt fragmentation and strengthentheSingleMarket, theESAsneedtofoster supervisoryconvergence, amongst others, through a strong rolein supervisory collegesand through the development of both the EU-wideSingleRulebook and SupervisoryHandbooks.At thepoliticallevel, EU leadersneed topressaheadwiththeestablishment of BankingUnion, includingSSM, and bank resolutionschemes.The financial crisis has increased financial institutions‘ attention tocounterparty credit risk, and loss of trust in implicit guarantees andcredit ratingshave ledto increased relianceon collateral.This increasingdemand for collateral hasbeen reinforced by regulatoryinitiatives,includingmandatory central clearingof some derivatives(EMIR) and bank capital rules(e.g. CVA charges), aswell asthe needfor banksto hold high-qualityliquiditybuffers and useof securitiesforaccessto central bank funding.Collateral safetyand liquidityis increasinglybeingpriced, incentivisingmore efficient use of collateralthrough collateral transformation (e.g.liquidityswaps) and reuse,leadingtoincreasedfinancial sectorinterconnectednessand cross-sectoralcontagion risks,encumbranceandSolvency ii Associationwww.solvency-ii-association.com
  97. P a g e | 97risksof pro-cyclicaleffectsin responsetoshocks tomarket pricesorratingsof either market participantsor collateral.TheESAs need to ensure that prudential ruleskeepup withtheevolution of market practicesand encouragepracticeswhichare bothmacro- and micro-prudentiallysound, and contributetoefficient, fairand stablemarkets.Financial market participantsremain concerned about thebalancesheetvaluation and risk disclosuresof financial institutions,and valuetheequityof manyEU financial institutionsat a significant discount to theirbook values.Financial institutionsshould valueall their assetsand liabilitiesproperly, in full accordancewithapplicableaccountingstandardsandregulations,toensurevaluation consistencywithintheEU, and shouldalsoanalyseand understand thesourcesof valuationuncertainty.This uncertaintyaffectsboth bankingbook and trading book assets, andultimatelythe valuation of capital.Supervisorsare stronglyencouraged to monitor and review thequalityofbanks‘assetsand thepractisesof bankstomeasure thequalityof theirassets.A particular problem for the insurance sector (due to delays to IASBconvergence work and Solvency II) is the continued absence of EU-harmonised accountingstandardsand regulatory valuation rules.Valuationand risk measurement (especiallyof complex instrumentsandlonger term risks) is generallybasedon quantitativemodels.For assetsand riskswhere firmsusesimilar or identical models, theyareconsequentlyexposed to risksof valuation shocksarisingfrom modelfailures and recalibrations.Solvency ii Associationwww.solvency-ii-association.com
  98. P a g e | 98Additionally, much of the valuation uncertaintyrelatestofinancialinstitutionsexposurestothe aforementioned common risk factorsofmacro-economic outlook, interestratesand collateralvalues.Supervisorsare encouragedtoset appropriate incentivesto correct forpotential distortionstovaluation and tocontributeby thesemeanstotheultimate goal of theprotection of consumersand investors.Confidencein financial market benchmarkssuffered in 2012, aspreviousmisconduct in banks‘submission of benchmark interest ratescame tolight.ESMA and EBA have acted, in coordination withthe EU Commission,IOSCO and national authorities, toaddressthe flawsin benchmark ratesettingfor Euribor and other key benchmarks.While more workneedstobe done in designing sustainableresilientsolutionsfor settingof financial benchmarks,continuityof existingbenchmarks(whichare referencedby an enormousnumber and value offinancial contracts) alsoneedsto be maintained, e.g. by mitigatingtherisk of disruptivewithdrawalsfrom existingrate-settingpanels.Theaboveisnot an exhaustivelist of risksfacingthe EU financialsystem, but comprisesthose whichthe Joint Committeeof the ESAsfeltweresufficientlycross-sectoralin nature tomerit co-ordinatedCommunity-widecross-sectorallyconsistent policy response,withbroadpoliticalsupport.INTRODUCTIONTheEuropean financial system facesa rangeof risks and challenges:1.Risks from theweak macroeconomicoutlook for thefinancial health ofreal-economy and sovereign borrowers, and consequentlyfor financialinstitutions‘asset qualityand profitability;Solvency ii Associationwww.solvency-ii-association.com
  99. P a g e | 992.Risksof a prolonged period of low interest ratesimpactinginsurersandpension funds, increasingsearch for yield behaviour and facilitatingwidespreadforbearanceby banks;3.Risksof further fragmentation of the singlemarket in financialservicesdue to evidencesof national retrenchment, home bias,reducedcross-border activityand clusteringof markets;4. Risksfrom increasedrelianceon collateralin financial transactions;5. Risksto confidencein financial institutionsbalancesheet valuationsand risk disclosures;and6. Risksof lossof confidencein financial market benchmarks.Theserisks,although presented individuallyin thisreport, are highlyinterlinked and require a concerted responsebypolicy makersboth atthepolitical level and from the European System of FinancialSupervision includingtheEuropean SupervisoryAuthorities (ESAs).Suggested policyactionstorestore theconfidencein the financialsystem are presented at theend of somedescribed risks.Thechallengefacingpolicy makersis nothinglessthan torestoretheconfidenceand trust in the financial system that hasbeen eroded duringrecent years‘financial crises.1RISKSFROM AWEAK MACRO-ECONOMIC OUTLOOKDespiterecent improvementsin financial markets,themacro-economicoutlook(aspresented in the ECB‘sMonthlyBulletinof January 2013)remainsweak, withresidual downsiderisks.This weak EU macro-economic outlookhasimplicationsfor thefinancial positionof governmentsand private sector borrowersand forSolvency ii Associationwww.solvency-ii-association.com
  100. P a g e | 100the outlookfor property markets, and may lead to deteriorationin theprofitabilityand asset qualityof both banks and insurers.1.1BANKING SECTOR ASSET QUALITY,PROFITABILITY AND FUNDING RISKSProspectsof a depressed macro-environment going forwardexacerbateconcernson bank asset qualityand their valuation.While bankshave significantlystrengthenedtheir capital positionsoverthelast twoyears, supported by the EBA recapitalisation exercise, thereare concernsabout impact on capital from potential future loan lossesasasset qualitydeteriorates.Non-performingloanshavebeen rising fast, while at thesame timeloanlosscoverageratioshaveremained steady(seeFigure 1and Figure 2).Acontinued adverseenvironment wouldcontributeto further risingnon-performing loans(NPL) and loan lossprovisions.Thenecessaryworkingout of problem loansin banks‘bookswilladditionallycontinueto generaterisks, adding to challengestorestoremarket confidence on credit portfolios.Solvency ii Associationwww.solvency-ii-association.com
  101. P a g e | 101Asset qualityconcernsare aggravated by widespreadloanforbearance,asthis practicemayhavecontributed to underestimatethescaleof problem loans.In many banksdeteriorating asset qualityhas resultedfrom over-exposure tothe real estatesector.Theoutlook for residential and commercial real estatepricedevelopmentsremainsweak, reflectingsubdued demand for housing, aswell asthe need tocorrect the still relativelyhigh degreeof propertymarket overvaluation in several countries.Thedeterioratingeconomicoutlook alsoaddstotheuncertaintysurroundingfuturedevelopmentsof real estateprices.For that reason, a number of banksremain vulnerable to increasesinnon-performingloanswithanyadditional property pricecorrectionsleadingtofurther deteriorationin asset quality.Somebanks may now need to addresstheissueof distresseddebt andunsustainableloanforbearancein a more structured and efficientway, constructively dealingwiththe issueof unsustainabledebt, whileensuring that borrowersstill have appropriateincentivestoservicedebt.Theweakeconomicenvironment may furthermore lead to continuedlowrevenuesand continuedlowprofitabilityof banks.Low-profitability banks havedifficultiesfinding equityinvestorsandthereforedepend on lowerretained profitsin order tomeet regulatoryrequirements.Profitability may befurther hamperedby conduct redresscoststhat somebanksface asa consequenceof past conduct of businesspractices.Fundingconditionsfor banks have significantlyimproved in mostgeographiesin the past monthsfollowingconcretemeasuresandannouncementsof the ECB‘s Outright MonetaryTransactions(OMT)Solvency ii Associationwww.solvency-ii-association.com
  102. P a g e | 102andtheSingleSupervisoryMechanism(SSM), amongst other importantinitiatives,and there are hopesthat the bank sovereignlink is weakened.However, a largenumber of bankscontinuetobe heavily supported bycentral bank funding, leavinga return tolastingand stablesourcesofmarket fundinga challengefor manybanks.Benign market fundingconditionsof thepastmonthsarestill fragile, inparticular in light of potential implicationsfor banks stemmingfrom aweakeconomicoutlook and asset qualityconcerns.Supervisorsare stronglyencouraged to make further progressonreviewingthequalityof banks‘assetsand the practisesof banks tomeasurethequalityof their assets.While policy announcementsand concretemeasuressucceededinsignificantlyreducingtail risksfor European banks, at least temporarily,thecurrent environment neverthelesscontinuestoprovidesignificantchallenges,in particular in banking systems withfinancially-stressedsovereigns,assignificant structural stressesstill prevail.Elevatedsovereign risk premia for financiallystrainedEU countries havenarrowedmarkedlysinceAugust 2012,suggesting a reduction in marketperceptionsof euroarea sovereign risk, particularlyin the periphery.However, uncertaintiesremain over important aspectsandimplementationof EU institutional reforms, suchuncertaintiesaboutfutureactionsmay negatively affectthe current respitein sovereign debtandbank fundingmarkets.1.2 DECLINING PREMIUM GROWTH IN THEINSURANCE SECTORAweakmacroeconomic environment impactsthe insurancesector in anumber of ways.Solvency ii Associationwww.solvency-ii-association.com
  103. P a g e | 103Generally, premiumstend todrop during recessions(although often witha lag), in particularin the life sector.Figure 3 showsthe effect on grosswrittenpremiumsduring therecenteconomicdownturnfor the largest European life insurerson anaggregatedbasis.Indeed, premium growthwasnegative throughout 2011asthe macro-economicenvironment hasput pressure on the saleof life insurancepoliciesin countrieswherehousehold wealthand income hasbeenreduced.Fiscaladjustment to reduce public sector deficitsin many countrieswouldalsolimit thepotential growthof insurancevolumes.This could happen both directly, through increasedtaxationonpremiumsor reduced tax incentivesfor long-term life and savingsproducts,or indirectlyfollowinggeneral tax increasesand reduceddisposableincome.Moreover, high levelsof unemployment combined with lowlevelsSolvency ii Associationwww.solvency-ii-association.com
  104. P a g e | 104of interest ratesmay alsolead to earlysurrendersin the life sector, inparticular for productswithout guaranteed returnsascustomersavoidsurrenderingpolicieswith(high) guaranteed returns.This would naturallylead to an adverseselection from the point of viewof the insurer.In addition, thedeleveragingobjectivesestablishedfor the bankingsector have ledtoincreasedcompetition from bankstrying toincreasetheir deposit fundingbase, which in turn is reflectedin decreasinglifeinsurancebusiness.In some countries,household investment in government bondsis alsoaform of saving whichcompetesdirectlywith certain life insuranceproducts.Finally, the current lowlevel of risk free interest ratesfollowingthe weakmacroeconomicclimateis a particular concern in the life insurancesector, both in termsof lowerprofit from investment income, but alsointermsof increased value of liabilities.In the non-life insurancesector, Figure 4 showsthat year-on-year growthhasremainedpositive, but the differencebetweenthebest and the worstperformers(indicated by theshaded areacovering the 10th and 90thpercentile) isincreasing, indicatinga divergingdevelopment in Europe.It is likely that increasingunemployment and reduced net householdincome will decreasethe demand for non-life productssuchasmotorpolicies(with exception of compulsory third-partyliability) and workerscompensation insurance.Fraudulent claimsin thenon-life sector may alsorisein a recessionaryenvironment, although the impact on insurersis generallyseen assmallcompared to thepeak in claimsfollowingnatural catastrophes.SolvencyI ratiosare generallyadequate, even if some insurersareexperiencingpressure on their solvencycoverage.Solvency ii Associationwww.solvency-ii-association.com
  105. P a g e | 105However, Solvency I ratiosgenerallydo not reflect the capital positionsof insurerson a market value basis.Market valuationwouldmost likely result in higher valuationofliabilitiesand possiblylowervaluation of (parts of) theasset portfolio.Thecapital position of insurerswouldthereforebe worseon a marketvalue(i.e. SolvencyII) basis.1.3 IMPLICATIONS FOR FINANCIAL MARKETSA continued weak macroeconomic environment and the prospect of anextended low-interest rate environment impose several potential threatstomarket participantsin securitiesmarkets.First, lowreturnsincentivize search-for-yield strategies,eventuallyincreasingthe likelihoodthat investorstake on positionswithelevatedrisk levels, and promote theacceptanceof leverage.Second, liquidityon short-term marketsaswell asthe revival of any formof unsecured fundingareboth negativelyaffected by lowinterestrates,becausepotential buyers‘appetitesare rather subdued.The latter effect also implies an increasing demand for collateral and theassociated potential for a relative scarcity of collateral discussed in moredetail in section 4.Third, prolongedmacroeconomic weakness, low interest ratesand thedistinctivetreatment of sovereign bondsin term of risk weightsmayincentivizeregulated firms‘investment in sovereignbondsand(indirectly) theissuanceof sovereign debt.This could implypotential bubblesin sovereignbond prices, especiallyfor markets exposedto severe public debt problems,but alsofor marketson whichsubstitutesare traded.Solvency ii Associationwww.solvency-ii-association.com
  106. P a g e | 106Fourth, a prolonged weak macroeconomic environment associated withpotential increases in unemployment rates is likely to affect households‘saving volumesnegatively.Hence, ultimately domestic retail funding sources would be reduced inthe most troubled markets and negative impacts on assets prices and ahigher dependenceon international fundingwouldbe generated.All thoseeffectswouldimpact on the assetssideof financialintermediaries‘balancesheets,be it banks, insurersor other financialintermediaries.Thus, cross-sectoralfeed-back effectswouldbe highly probable.1.4 FINANCIAL REGULATION AND ECONOMICPERFORMANCETheemergingregulatorylandscapefor banking, insuranceand financialmarket participantsin general createsa resilient framework for theEUfinancial sector.Many important elements of the future framework are still in the processof being finalised, and uncertainties on timing and cumulative effects ofvariousinitiativescreatesome short term challenges.Moreover, theneed tore-establish economic growthhasledtopoliticalpressuresfor encouragement of the supplyof credit tothe real economy,whetherfrom banks, insurersor pension fundsor via market-basedintermediation.For instance, due totheir long-term liabilities,insurersand pensionfundsare seen aspotential sourcesof financefor long-term investments.TheEuropean Commission hasthereforeasked EIOPAand EBA toanalysethe effect of financial regulationon availabilityof financingforthereal economy, particularlyinfrastructureinvestments, private equitySolvency ii Associationwww.solvency-ii-association.com
  107. P a g e | 107or SME financing, toinform on-goingnegotiationsof SolvencyII andCRR/ CRD IV.One phenomenon revealedby the2008financial crisiswasthecross-sectoral interconnectednessand complexityresultingfrom therepackagingof variousdebt forms bymeansof securitization, financialengineeringand similar techniquesinvolving thechange of riskcharacteristicsalongthe way.Inadequate accounting, disclosure and prudential requirementshid theunderlying financial and behavioural risksbehind such complexintermediation.Thecrisisledtoa lossof confidencein such financial intermediation,and consequent regulatory reformstotighten up prudential anddisclosurerequirementsto restore confidencein the financial system.Howeverthe commercial and political pressuresfor thefinancial sectortoprovidelongterm financingtothe real economy, while not overtlyexposingretail depositors,policy holdersand retail investorstotherisksinherent in the provision of long-term risk financing, areagainincreasingthe incentivesfor firms toarbitragearound new regulatoryrequirementsand increasecomplexcross-sectoraltransformation offinancial promises.Unlessproperly designed, initiativestostimulate growth run the riskofdivertingscarcefundsawayfrom their most productiveuses, and notnecessarilyincreasingaggregate demand in the economy.But, for the caseof liquidityhoardingby financial market participants,additional demand stimuli can have potentiallypositiveeffectsonexpectationsand investment plans.Nevertheless, makingchangesin light of a financial crisisrunsthe riskofa short term fix instead of a viablelong term solution, and may lead tocomplacencyand reduced commitment tostructural reformsand theinternationallyagreed Financial RegulatoryReform agenda.Solvency ii Associationwww.solvency-ii-association.com
  108. P a g e | 108Regulationshouldbe designed in such a waythat it is not amajorobstacletogrowth, but is hastoview risk consistentlyacrossbalancesheets.This would for instanceimplythat any recalibration of Solvency IIcapital requirementsneedstobe actuariallyand economicallysound.Finally, anychangesfor one financial industry needtotakeaccount ofdevelopmentsin other sectors, soasto prevent regulatory arbitrageandmaintainconsistencyacrosssectors.2 RISKSFROM PROLONGED LOW IN TEREST RATESThemacro-economicdown-turn followingthe financial crisishasnecessitateda concerted policy response,especiallyfrom monetaryauthorities,whohaveloweredpolicy interest ratesand expanded theirrangeof monetary operations(seeFigure5).Market expectations, influencedby central bank communications,areincreasinglyfor interest ratesto remain low for significantlylonger time.Solvency ii Associationwww.solvency-ii-association.com
  109. P a g e | 109Aprolonged period of low interest ratesmay haveprofounddistributional effects, supporting borrowersand reducinginterestincome for savers.Withinthe financial sector, low interest ratesgenerallysupport banks byreducing fundingcostsand credit risk, but hurt insurersby increasingthepresent valueof liabilitiesand depressingreinvestment returns.Somebanks may alsobe negatively affectedby an overall reduction innet interest margins(see2.2).Thechallengefor financial regulationand supervision is toensure that,consistentlyacrossthe EU, financial institutionsfullyrecogniseandmanagethe direct and indirect interestrate risksto ensure resilienceagainst therisksboth of a prolonged period of lowinterestratesand ofanysharp adjustment tointerestrates.Thecontinueddelayof SolvencyII representsa challengefor achievingthisin the insurancesector.One of thereasonsfor thedelay, however, is thecontinued discussionofcertain technical aspectsof SolvencyII includingthe long termguaranteepackage.EIOPA is currentlyassessingthis issue.2.1INSURANCE SOLVENCY PRESSURESTheexistenceof a prolongedlowinterest rate environment harmsinsuranceundertakingsbyincreasingthe present valueof liabilitiesandbydepressingreinvestment returns.In turn, ascapital market ratesapproachthe guaranteed rate, insurersfaceincreasingdifficultiestomeet performance guaranteesprovided oncertaininsurancecontracts.Solvency ii Associationwww.solvency-ii-association.com
  110. P a g e | 110Consequently, compression of this margin beyond a given point wouldcausean erosion of thecapital positionof some segmentsof theindustry.In general, lowinterest ratesare particularlydetrimental for life insurersanddefined-benefit pension funds, giveni)Their largeexposure topredominatelyfixed-incomeassets,ii)Thefact that theytypically have a negativeduration gap, withliabilitiesof longer duration than assets,andiii)Thefact that their productsmight includeperformanceguarantees.Wherehistorical cost accountinginsteadof market consistent valuationisapplied, theeffect of the lowinterest ratesis not immediatelyvisible.However, the impact of a prolonged low-interest environment dependson the type of insurance business, its exposure to interest rate risk andperiod over whichinterest ratesare depressed.It alsodependson the market in whichthe insureroperates, and on therelevant government bondsyield curves.Individual reportson the interestrate sensitivityof European insurerscollectedby SwissRe show that companiesdomiciled in central andnorthern European marketsare themost exposedtofurther declinesininterest rates.Thesensitivityis generallydue to long and rigid guaranteesofferedtopolicy holders.SwissRe findsthat interest rate sensitivityis generallylowerin southernEurope and France, aswell asin the UK.Solvency ii Associationwww.solvency-ii-association.com
  111. P a g e | 111The dimensions of the potential problems associated with a prolongedperiod of low interest ratesare difficult to estimate, although a numberof studieshave been produced.TheEIOPA stresstest on a low-yield scenario carried out in 2011revealedthat 5% to10% of the companiesincluded in the samplewouldfacesevere problemsif theprolonged low interest environment remains,inthesensethat their ratio of solvencyto theminimum capital requirement(MCR) would fall below 100%.In addition, many companieswouldonly be able tomaintain solvencyratesslightlyabove the 100% mark, makingthem vulnerable tootherpotential external shocks.TheEIOPA stresstest clearlyshowedthat theeffectsof low interestrateson the liability sideoutweigh any temporary asset valuation gainson fixedincome investments.Internal research byEIOPA hashighlightedthechallengesfaced bynational supervisoryauthoritiesand individual insurersin responding totherisksposed by lowinterest rates.EIOPA is thereforeworking withnational supervisorstoidentify suitablesupervisorymeasuresand tofurther quantify the extent of thedetrimentaleffect of thecurrent low interest rates.In thisregard, EIOPAhaspublished anopinion on thesupervisoryresponseto a prolonged lowinterestrateenvironment.Theopinion addressesthemain challengesthe for the insurancesectorposed by a low interest rateenvironment, promotesadoption of privatesector solutionsand expressesEIOPA‘s viewson thesupervisoryresponsestothis environment.EIOPA will alsocarryout a follow-upexercisewith Memberswiththeaim toassessthe scaleof this issueand wherethe greatest impactslie.Solvency ii Associationwww.solvency-ii-association.com
  112. P a g e | 112As the likelihoodof a prolonged period of lownominal interest ratesincreases, individual insurersalsoneed tofind suitabletoolstomitigatetheeffect of such periods. Onepossibilityis to re-price products.However, thissolution is generallyonly possiblefor new businessanddoesnot addressthosecontractsthat arealready on the booksof theundertakings.Guaranteeson current contractswouldgenerallyneed to be honouredand funded through cross- or intra-product subsidization, or throughreserves.Immediatechallengesmay be somewhat relieved if life insurancecompanies are allowedto smooth the returnsover the life of the contract.Insurerscould alsoaim to redesign their product portfolio.This would generallyinvolve a movetowardsproductsthat performbetterin the current market conditions(e.g. unit-linkedproducts, inwhichthe riskis shiftedtothepolicyholder) and thediscontinuationofsellingnew guaranteedproducts.Ashift towardsproductsthat are not heavily dependent on investmentincome (e.g. productswithindexed annuities)wouldbe beneficial.Under certain circumstances,insurersand pension fundsmay be abletorenegotiateor unilaterallyadjust existing contractswiththe aim ofaccommodatingthetermsof the guaranteestothe current marketconditions.Reputational considerations,however, oftenmake thisunrealistic,sincefuturebusinesswouldbe likely to be severelyharmed aspolicyholderswouldshy awayfrom buying insuranceproducts.Policyholdersare naturallynot willingtogive up relativelylucrativeguaranteesand insurerswill generallyhave to continue offeringthesetypesof products.Solvency ii Associationwww.solvency-ii-association.com
  113. P a g e | 113Legal constraintswouldalso, in most jurisdictions,not allowor onlyallowthis asa last resort measure, whenthere is an overall risk of failureof the insurer.2.2 BANKING SECTOR: MARGIN PRESSURES ANDCREDITOR FORBEARANCEPersistent low interestratesare alsoputtingpressureon thebusinessmodel sustainability of bankswhichfind deposit interestmargins,andthereforeoverall net interest margins, squeezed, contributingtoprofitabilitypressures.This hasledmany bankstoseek other sourcesof revenue, includingfeesand commissionsfrom cross-sellingother financial products, andincentivised searchfor yield behaviour, although some have facedconduct redresscostsfor past salesof unsuitablefinancial products.Low interest ratesreducenear-term default risk on credit exposuresbysupportingborrowers‘abilityto servicetheir debt (helpingtopartiallyoff-set thenegative impact from the weak macro-economicenvironment), but alsoprovidedirect and indirect incentivesfor creditorforbearance.Low interest ratesreducethe near term financial or opportunitycost offorbearingon loanswithrisk of future impairments.And, indirectly, the decreasing margins, cost-reducing pressures anddepressed values of some of the assets pledged as collateral, may givebanksfurther incentivestoforbear on loans.There are, unfortunately, clear risks associatedwithforbearance,especiallyif not properlyrecognisedand managed.However, prolonged lowinterest ratesalsoposetherisk of a sudden rise,whichwouldfurther aggravateshort term asset qualityconcerns, asborrowers‘abilityto repay loansdeteriorates.Solvency ii Associationwww.solvency-ii-association.com
  114. P a g e | 114Asudden riseof interest rateswouldalsoincreasefunding costsandcould result in tighteningof interestmargin, especiallyin caseof lendingwith longer repricingperiods.While protractedlow interest rateshavecontributedtopriceincreasesinsome asset classes, in particularin the housingmarket, an environment oflowinterest ratesin the current junctureis thusprudentiallypreferableforthebanking sector over an environment of sudden risesof interestrates.Suddeninterest rate rises wouldalsogenerate lossesin fixedincomeassets.Low interest ratesneverthelesscontinueto contributetodelaysinbalancesheet repairs,toa slowerpace of deleveraging, and tocompressed margins.2.3 FINANCIAL MARKETS: SEARCH FOR YIELDBEHAVIOURMany market participantsstill have target ratesof returnssignificantlyabovecurrent risk-freeinterestrates,whetherdrivenby existingcontractual liabilitiesor by stakeholder expectations.Low interest ratesincentivize market participantstoseek higher yieldsinvariousways, includinginvestingin lessliquid assetsand takingriskswith off-balancesheet investment vehicles.Financial marketshaverallied sinceAugust 2012,asthe ECB‘s promisetodo ‗whateverit takes‘reassured investorsthat tail risksfor financialmarketshad receded.Sovereign and corporate bond yieldsin both advancedand emergingeconomieshavenarrowedmarkedly.Spreadsare again closetolong-term historical averages.Solvency ii Associationwww.solvency-ii-association.com
  115. P a g e | 115However, a reassessment of credit risksmay makethese spreadstowidenagain given the potential increaseof defaults againstthe backdrop of theweakmacro-economicoutlook.Recently, concernshavebeen raisedbythe ECB‘sBond Market ContactGroup that the negativenominal yields for some non-distressedsovereignbondsin the short end might not reflect fair values;and that the recenthunt for yield wasleadingto lowerbond yieldsin thosecountrieswherethegrowth outlook wasstill unsatisfactory, whichpointed toadecouplingbetweenflowsand fundamentals.Thesedevelopmentsimplysome risksof thedevelopment of mis-valuationsin sovereign bond markets.Market improvementshave alsospreaddownthecredit spectrum tohigh-yieldbonds, withnarrowingcredit spreadsand increasingissuanceactivity.This hasmainlybeen in the establishedUS high-yield bond andleveragedloan markets, wheretherehave alsobeen a sign of areemergenceof lessprudent pre-crisisactivities,such asCLOs,covenant-liteloans,payment-in-kind toggles,CMBSand non-agencyRMBS, suggesting a return of investor riskappetite.Sofar, thesearch-for-yield hasmainlyoccurred in wholesalemarkets,anddid not reach retail marketsin whicha continueddeclineof thevolume of structuredproductssold to retail investorshasbeen observed(seeFigure 6).Nevertheless, thenumber of structured productssoldincreased(seeFigure 7), whilethe maturitydecreasedover the last few years.Retail investorsmay well be more riskawaresincethe financial crisisand remain cautiousabout returningtoa somewhat tainted asset class,while lowinterest rateshave made it more difficult for financialinstitutionsto offer compellingproducts.Solvency ii Associationwww.solvency-ii-association.com
  116. P a g e | 116Market volatilityindices,whichhave becomea tradableasset class, havealsonarrowed.This has the effect of reducing the value-at-risk (VaR) measures andcapital requirements for some trading book activities, and making itcheaper (in capital terms) to take financial risks.However, historical time seriesfor volatilityindicesexhibit patternsofprolonged declinespunctuated by sharp jumps in volatility.Such volatilityjumps,if they weretohappen, wouldsharply increaseVaR measuresand capital requirements, whichcould trigger andreinforcenegative market dynamicsfrom forced sellingby VaR- orcapital-constrainedmarket participants,risk-sensitivemargin andcollateral requirements– a phenomenonknown asVaR shocks.Lifeinsuranceundertakingsand occupational pension fundswhichofferproductswithguaranteed interest ratesmight strugglein earning theseinterest rateswithout adaptingtheir original investment policy.It is, however,difficult to quantify the actual extent of searchfor yieldbehaviour.Solvency ii Associationwww.solvency-ii-association.com
  117. P a g e | 117Asurveyrun by EIOPAamong national supervisoryauthoritiesinAutumn 2012revealed no clearpicture for theperiod from 2011to2012.Although the number of jurisdictionsreportingat least someobservationsof an increasedsearch-for-yield behaviour wasgreater thanthenumber of jurisdictionsnot reportingsuch findings,aggregated dataon theinvestment portfoliosof largeinsurancegroupscannot underpinanytrend of switchingbetweenmajor asset classes(e.g. from sovereigntocorporatebonds, or from bondstoequity).Potential searchfor yield behavior involving investingintolowerratedassetsor bondswitha longer maturityis alsodifficult to identify withaggregateddata asany such investment pattern could be masked byvariousother factorslike a downward ratingmigration in thebondportfolio witha subsequent changein thevalue of theseassets.Lack of flowdata makesportfolio shiftsdifficult toidentify and thegeneral problemsin quantifying thesearchfor yield are alsorecognisedbyother institutions,like e.g. the OECD.However, aslongasthe regulatoryframeworkis not risk sensitive,insurershave incentivestoincreaserisksin order toincreasereturnsontheir portfolios.3 RISKSOF FURTHER FRAGMENTATION OF THESINGLE MARKETTheSingleMarket isone of theEuropean Union‘sgreatestachievements.However, the current economic situation is characterisedbystrong on-goingevidencesof fragmentationof theEU SingleMarketand of national retrenchment with a biasfor domesticmarkets.3.1INCREASED HOME BIASAND REDUCED CROSS-BORDER BANKING ACTIVITYSolvency ii Associationwww.solvency-ii-association.com
  118. P a g e | 118Theprocessof EU and Euro-area financial integrationand cross-borderbankinghasstalledduring thefinancial crisis, and bankshave reducedinternational exposures,increasingthe riskof fragmentationof theSingleMarket.Asignificant decreaseof interbank flowsacrossborders, a reduction offoreign claims(seeFigure 8) and a substantial wideningof crossborderlendingratesprovide further evidencesof increasingretrenchment.There is alsosome evidenceof increasedhome biasin asset holdingsintheinsurancesector(although a certain level of home bias isinherent inthebusinessmodels and risk management of insurerswitha domesticcustomer base).Theseon-goingstrongevidencesof fragmentation and retrenchment rollback some integrationgainsachievedsofar and risk underminingthefoundationsof the SingleMarket.This exacerbatesconcernsabout financial stabilityin Europe and assuch signalsa lack of confidence.Signsof fragmentationcan be traced to both ―public‖ and ―private‖drivers,with each reinforcingthe other.Solvency ii Associationwww.solvency-ii-association.com
  119. P a g e | 119Privatedriversof fragmentation reflect changesin the risk appetiteofinstitutionstowardsde-risking.This includesbusinessstrategiestowardsexitingor scalingback fromregionsor businesses.In recent times,many bankshave startedto diminish their foreignexposuresdue to higher fundingcosts,general risk aversion, andchallengingconditionstoexplore operational synergies.Also, bankshavebeen under pressure todeleverage assetswheredifficultiesareexperiencedtoobtain fundingtosupport theseassets.For instance, a lack of funding in USD for somebanks hascaused ascaling down of businesseswhereglobal transactionsare mainlydenominatedin USD, such asaircraft financing.At the same time, close-out transactionsamongbanksacrossbordersareleadingtoa severe slowdownin cross-border interbank activities.TheEBA‘s Risk Assessment Report, in itssemi-annual survey, providessomeevidenceof thison-going retrenchment (see Figure 9 and Figure10).Publicdriversreflect, among other issues, uncoordinatednational policymeasurestakenby some national regulators,includingring-fencinglocalcapital and liquidity, divergingsupervisory practisesand informalrequirements,e.g. to locallymatch liabilitiesand assetsto mitigateperceived currencyredenomination risks.While banksmay want tooptimize fundingpositionsthrough intra-group transfers, some home and host authoritieshave undertaken aseriesof unilateral ring-fencingmeasuresto localcapital and liquidity.For instance, measures were imposed to reduce exposures of banks toaffiliated entities mainly impacting transactions between subsidiariesandtheir foreign parent banks, limitingintra-group lending.Solvency ii Associationwww.solvency-ii-association.com
  120. P a g e | 120Uncoordinatednational policymeasuressuch asregulatory ring-fencingrequirements(evenwherethere is no clearlyspecified and EU-widestructural framework) risk hinderingthefree movement ofcapital, increasingthe cost of funding, signallingsupervisorydivergences,influencingnegativerating actions,and provokingfurthersafeguardmeasures.Moreover, funding challengescan alsoexacerbatepressureson domesticbanksand their sovereigns.For instance, national bailouts and other localsupport measurestosupport localbankscan have a negativeimpact on debt dynamics andincreasesystemic risk in a self-enforcingmanner.Concernsabout fiscal costsof bailing-out a largefinancial institution canadverselyaffect theborrowingcostsof thesovereign the institutionisdomiciledin, partly becauseof the anticipatedimpact on debt dynamics.In the context of fragmentation in financial services, thisis a particularrisk wherealreadycloselinksbetweenbanks and their stressedsovereignsare increasingfurther.Consequently, coordinatedpolicy responsesacrossMemberStatesand aclearlyspecified and sustainableEU-widestructural framework forsupervisorycoordination are neededtoreinforcesupervisoryconvergenceand torapidlyreverse harmful trendsof fragmentation of theEU SingleMarket.Furthermore, the 0% risk weight asassignedtosovereign exposuresinbankingand insuranceregulation may havebeen a further driver ofmarket fragmentation to theextent that it hassupported purchasesofpredominantlydomesticgovernment debt, contributingnot only tofragmentation, but alsotoincreasingbank-sovereign links.Solvency ii Associationwww.solvency-ii-association.com
  121. P a g e | 1213.2 IN CREASED CLUSTERING OF FINANCIALMARKETSFinancial marketswithinthe EU have displayed since2011signsof aclusteringof marketsintotwobroad main groups.Main manifestationsof this clusteringcan be seen in an increasingdispersion of EU equityindices,a continuing high dispersion in theyieldson EU sovereign bondsand the formationof twogroupswithinternallyhigh correlation coefficientsbetweensovereign bond yieldsand low correlationsbetweeneach other, neverthelesswithpotentialspill-overeffects.Tobe sure, thisclusteringdoesnot mark a fragmentation of the EUsinglefinancial market.It rather reflectsa realignment of risk assessmentswithinthemarket,while the integrityof the singleEU financial market and itslegal andinstitutional infrastructureremainsunimpairedby this economicdevelopment.In detail, the general upwardtrend in equityindiceshasnot included allEU countries,asat least onesmaller country experienced a furtherSolvency ii Associationwww.solvency-ii-association.com
  122. P a g e | 122declinein itsequityindextherebyfurther increasingthedispersion ofequitymarket indices.SinceJanuary2011the weakest performer haslost about 80 percentageofitsvalue, while the best performer hasgained roughly20 percentagepointsin value.In particular, the European banking sectors have, since July 2012, beencharacterized by an increased dispersion of equity indexes (see Figure11).At sovereign bond markets,the yieldsfor almost all EU countrieshavefallensinceJuly2012.However, sovereign bond yields for several member statesremain on anelevatedlevel, i.e. well above 4percentagepoints,and producea stillconsiderable amount of heterogeneityacrossEU membersreflectedinan absolutedispersionof around 10percentagepoints.This impression is alsoconfirmed by correlationsbetweensovereignbond yields of EU member states(seeFigure12).Solvency ii Associationwww.solvency-ii-association.com
  123. P a g e | 123In particular, from April 2012onwardsthecorrelationdata indicatesthata first group of countries comprising distressed economieshasbecomeseparatedfrom oneof lessdistressedmembers.This second group, represented by Finlandin Figure12, is characterizedbya high correlation to membersof the same group, but volatile anddecreasingcorrelationstomembers of thefirst group.Hence, in particular sovereign bond marketsdisplaythe tendencytoseetwomarket clusterswithin theEU.Thedevelopment of sovereign bond yield volatilitiessinceApril 2012reflectsthisevidenceby displaying a similar structure witha group ofdistressed countries characterizedbyhigh volatilitiesand a group of lessdistressed countries featuringsubstantiallylowervolatilities, wherebythedifferencein thevolatilitylevel belowthosegroupsisa littlebelow100%of the second group‘svolatility.Similarly, the differencein the maturitiesof new debt issuedbysovereignsin 2012betweendistressed and non-distressedmarketsprovidesadditional evidencefor theclusteringof markets, assovereignsof distressedmarketsissued in 2012new debt withan averagematuritymore than three years lowerthan the averagematurityof issuesbynon-distressed sovereigns.Liquidityindicatorsdeliver additional evidencefor the increasingheterogeneityof sovereign bond marketsthroughout the EU byfeaturinga persistentlyhigh level of dispersion of bid-askspreadsbetweenselectedmarketsin late 2012.Theincreasedheterogeneityin EU sovereignbond marketsis alsoreflectedin thedevelopment of rating decisionsfor newlyissuedsovereigndebt in whichthe share of new issuanceswith lowerratingsincreasedthroughout the entire year 2012.Solvency ii Associationwww.solvency-ii-association.com
  124. P a g e | 124Thus, in 2012,54% of sovereignbondsissued wereratedAAA orAA+,against 60% in 2011;13% betweenAA andA- (40% in 2011) and 33%belowA(0.2% in 2011).While thetendencyfor an increasingmarket clusteringmay contribute toconcernsfrom aSingleMarket perspective, it alsomitigatescontagionrisk asinvestorsare increasinglyusing diverging risklevelsto distinguishcategoriesof sovereign debt in Europe.Nevertheless, contagion risksremain high withinthe group of countriesexposedtosovereign debt problemsand potential spill-overeffectswithin theEU cannot be neglected.In addition, thenegativecorrelation pattern betweendistressedand non-distressed European sovereign debt marketsindicatesthat investorsareincreasinglytreatingthetwotypes of sovereigndebt assubstitutesin theirportfolios.Consequently, theissuanceof new debt getsmore demandingforindividual sovereign issuersunder distress.In addition, theassociatedmaturity reduction preservesthismarketpressurewhichcurrentlygeneratessizeablesovereignspreads.From a cross-sectoral perspective, thesimultaneitybetweentheincreasingdispersion in themarketsfor equity, and in particular theequityof banks,and sovereign debt documentsthe risk of feed-backloopsbetweensovereign debt problemsand balancesheetsof thedomestic bankingsectors.In sofar asdomesticbanks are themain purchasersof sovereign debt,while sovereignshave to bail out endangeredbankingsystems, anynegativeeventsin one of the twosubsystemsimplies negative contagioneffectsfor the other.Solvency ii Associationwww.solvency-ii-association.com
  125. P a g e | 125Hence, the involved feed-back effectshave thepotential tocreatea self-reinforcingpersistenceof theunderlying problemscontributingtoeventual strainson theSingleMarket framework.3.3 ESA‘SRESPONSE TO REVERSE THE TREND OFFRAGMENTATIONAll EU institutionsand member statesneed toworktogether to reversetheharmful trendsof fragmentation of the EU SingleMarket.Arange of initiativeswill be relevant, especiallyin the Eurozone,includingthe SSM, whichwill be instrumental in breakingthe adversebank-sovereignlink.TheSSM should beimplemented without delay, and shouldbe followedbya sound bank resolution mechanism.To supplement those measures, an increased emphasis should be placedon the ESAs role to promote convergence of supervisory practices and tocoordinatepolicy responsesacrossMember States.Here, a strong role of the ESAsin supervisory collegesand thedevelopment of both theEU-wideSingleRulebooksand SupervisoryHandbookstofoster supervisoryconvergenceare of particularimportance.Theproper functioningof collegesof supervisors,asa keyforum foreffectivesupervisorycoordination and exchangeof information, is a veryimportant element in achieving supervisoryconvergence and coordinatedsupervisoryresponses.Supervisorycollegesare very well placed toplay a significant role inaddressingcurrent risksof uncoordinatednational actionsand inassessingunintended consequencesof such actions.Solvency ii Associationwww.solvency-ii-association.com
  126. P a g e | 126Tothisend, the ESAs‘ engagement in collegesof supervisorshelpstoensure that supervisorymeasuresare properly discussedand coordinatedex-ante,and that collegestake potential unintended consequencesintofull account in their joint assessmentsand decisionson institution-specific prudential requirements.Consequently, theESAsshould havea strong rolein supervisorycollegesin order to efficientlycoordinatethepotential implicationsof nationalpolicy measuresacrossMember States,and thustoprevent furtherfragmentationof theEU SingleMarket.Astrong involvement of the ESAs in collegescan be viewedasa naturaldevelopment duetotheir EU wideexpertise and oversight of theoperational functioningof colleges, enablingthem tocollateinterpretationsof existingstandardsand regulation, and to provideorientation and feedback on how supervisorscan substantiatetheirassessmentsof risksin financial institutions.Moreover, thedevelopment of the EU-widesinglerulebook should settheright signal for a long-term structural regulatory framework.Such a framework wouldset a level playing field and improvecompetitivenessof the financial sector aswell asoverall confidenceinEU financial markets.It should build on theeffortsand progressesmadesofar by theESAstowardsthisobjective.Already, primary legislations,includingEMIR, AIFMD, SSR and CRA2, aswell astechnical standardsandguidelines,e.g. forAIFMD, EMIR, UCITS,CSD, MiFiD and CRA2 marksignificant progresstowardsthesinglerule book.Further measures to promote the single rulebook are planned in the areaof the transparency of investment products, the enforcement for financialinformation and theworktowardsMiFiD2.Solvency ii Associationwww.solvency-ii-association.com
  127. P a g e | 127With regard tothe bankingsector, the development of an EU-wideSupervisoryHandbook (Handbook) by the EBA could be a veryimportant element tocomplement the EU-wide SingleRulebook.In particular, a Handbook would ensureconsistencyof supervisorypractisesand could addressfragmentationrisksbyminimisingthe riskof regulatory arbitrageand by ensuring consistencyof supervisorypractisesbetweencountries insideand outsidethe SSM.This is particularlyimportant in relationtocross-borderbankinggroupswithin theEU in order toprovidea common referencepoint todecide ontheapplicationof supervisorymeasures,and in the processof jointdecision on institution-specific prudential requirements.TheHandbook wouldbe based on good supervisorypractisesand wouldprovidecommon referencepointstodecideon the application ofsupervisorymeasures.All theseimportant elementsshould counteract signals of supervisorydivergencesthat arecurrentlycompromisingtheunityand integrityoftheEU SingleMarket.In thissense, an effectiveand credibleframework for theSSM must notcompromisetheunityand integrityof theEU SingleMarket, andshould, in fact, contributetoan effectiveapplicationof thesecrucialelementsof converge betweentheSSM and non-SSM countries.With regard tothe insurancesector, the present solvencyrulesareoutdated.Theyare not risksensitiveand theydonot properly deal withgroupsupervision.Importantly, theyhave alsobeen superseded by industry, internationaland cross-sectoraldevelopments.Solvency ii Associationwww.solvency-ii-association.com
  128. P a g e | 128SolvencyII will ensure the harmonizationof valuation methodsandsupervisorypracticesand help rectify theseshortfalls.Thecontinueddelaysin the implementation of SolvencyII, however, area sourceof uncertaintyboth for supervisorsand insurers.There is a clear riskthat, in the absenceof a final agreement on SolvencyII, Europeansupervisorsmay beforcedtodevelop national solutionsinorder to ensure sound risk sensitivesupervision.Instead of reachingconsistent and convergent supervisionin the EU,different national solutionsmay emergetothedetriment of a goodfunctioninginternalmarket.It is thereforeof key importancethat national authoritiesensure aconsistent and convergent approach withrespect to the preparationofSolvencyII.In particular, an interim implementation of key areas of Solvency II isimportant in order to ensure proper risk management in undertakingsandtoensure that supervisorshave sufficient information at hand.Thesekeyareascompromise the system of governance, includingriskmanagement system and a forward lookingassessment of theundertakingsown risks,preapplication of internal models, andreporting tosupervisors.4 RISKSFROM INCREASED RELIANCE ONCOLLATERALThefinancial crisis, and especiallythe failure of Lehman, increasedfinancial institutions‘awarenessof and aversion tocounterparty defaultrisk.Solvency ii Associationwww.solvency-ii-association.com
  129. P a g e | 129Havinglost confidencein credit ratings,firmsand investorshaveincreasedtheir relianceon collateral in managing counterparty defaultrisk.This tendencyhasbeen reinforced by regulatoryinitiativessuch asmandatorycentral clearingof derivativesasstipulatedin the EuropeanMarket InfrastructureRegulation (EMIR) aswell asCVA charges.Hence, fundingthrough unsecured interbank and bond marketshaspartiallybeen replacedby funding through secured repo and coveredbond markets.At the same time, the collapseof largeparts of theUSshadow bankingsystem, includingformerlyAAA-rated securitisedproducts,and the on-goingEuropean sovereign crisishave weighed on thesupplyof high-qualitycollateral.An additional factor hasbeen a reduction in thevelocity(or reuse) ofcollateral among market participants,which may put further pressure onthesupplyof collateral and the smooth functioningof financial markets.AccordingtoESMA‘sestimates, thesupplyof high quality collateralwithin theEU isaround EUR 11.8tn asof 2012,thebulk of whichconsistsof sovereignbonds.TheEU-widedemand for collateral is around EUR 4.1tn, mainlyfor repooperations,exchange-tradedand OTC derivativesand securities lending.On thewhole, theseestimatesdo not point tosubstantial imbalancesinthecurrent juncture, although the expectedincreasein demand in thenext few years (tomeet further mandated collateralisationrequirements)may exceedthe increasein supply, resultingin relativescarcityofcollateral.In addition, a pure aggregationdoesnot fully reflect the distribution ofcollateralavailability and collateral needsover individual institutions.Hence, eventual local scarcitiesof collateralcannot be ignored.Solvency ii Associationwww.solvency-ii-association.com
  130. P a g e | 1301.COLLATERAL TRANSFORMATION, RE-USE ANDINTERCONNECTEDNESSThesafety and liquidityvalueof collateral is increasinglybeingpriced,providingincentivesfor more efficient use of collateral.Institutionswithidleportfoliosof high-gradeliquid securitieshave moreincentivesto lend thesesecuritiestoinstitutionsthat have greater needfor liquiditybuffers.Institutionswithlower-gradesecuritieshaveincentivesto optimisetheircollateral use (e.g. posting cheapest-to-deliver collateral whereallowed)andtotransform their collateral (through collateral upgradetransactions)toimprove their accessto liquidityor extract liquiditypremium fromhigh-gradesecurities.Specific examplesof such increasedinterconnectednessand contagionrisk includethe collateral-basedtransaction chain betweenhedgefunds,prime brokersand the repomarket, and thecollateral upgradetransactionsbetweenbanks (needingbetter collateral) and insurers(needingextra income from idleholdingsof high-gradesecurities).Such collateral transformation should increasetheefficiencyof collateraluse,but may alsoreinforceseveral risksfor the financial system:- Financial institutionsmay pledge someassetstoget securedfunding, resultingin further asset encumbrance, whichraisesrisksfor unsecuredcreditors(depositorsand bondholders);- Financial institutionsfacingfunding issuesand lacking high qualitycollateral may enter intocollateral swaps(alsocalled collateralupgrade) with other institutionssuch asinsurance companies,resultingin an increasein theinterconnectednessin thefinancialsystem;Solvency ii Associationwww.solvency-ii-association.com
  131. P a g e | 131- Lower-qualityassetscould be used ascollateral. Sharp declineinpriceswouldthen lead to margin callsor changein haircuts,whichunder stresscould leadto procyclical effects.- Collateral reusemay increasefurther in order to addressthe relativescarcityof collateral.This wouldalsoincreaseinterconnectednessin the financialsystemandmay alsogenerateuncertaintiesfor beneficial owners.- Variationsin collateral demandsgeneratedby fluctuationsin theratingsof the counterparty, the ratingsof the collateral, and theValue-at-Risk(VaR) of thefinancial contract against whichcollateralisrequired can triggerforced sellingsor close-outs,whichwouldreinforcenegative market dynamics.Again, in a distressed situation, thiswould generateadditionalprocyclical effects.- Theextent towhichbankshave alreadypledged assetsin securedfundingmarkets(includingrepoand covered bonds), and the risksoffurther collateralcallsunder stress, is not generallywell disclosed,andpresentsanother source of uncertainty.Theseeffectswouldall make it more challengingto achieve(and lesscredibleto promise) orderly resolutionin theevent of financialinstitution failure, thereby increasingmoral hazard.4.2 THE ROLE OF CENTRAL COUNTERPARTIES (CCP)TheEuropean MarketsInfrastructureRegulation (EMIR) requiresallOTC derivativecontractsmeeting predefined eligibilitycriteria to beclearedthrough an authorised CCP.Solvency ii Associationwww.solvency-ii-association.com
  132. P a g e | 132Mandatoryclearingrequirementswill increasethequalityof riskmanagement, reducecounterpartyrisk acrosstheEU and allowthenettingof contractsacrossdifferent counterparties.Thustheygeneratethe benefitsof a potential reduction in the demandfor collateral.Competition pressuresbetweenCCPs are another aspectthat hasattractedregulatory attentionand hasled to stringent minimumrequirementsfor risk management on collateral, margin and theoveralldefault waterfall.On theother hand, EMIR alsoleadsto an increaseof transactionsvolumesclearedby largeEuropean central counterparties.In addition, it will contributetoa further increasein the demand for highqualitycollateral in thefinancial system, sincecollateral hastobeprovided for certain non-clearedOTC derivativecontracts.Thusriskconcentrationswill increase,sincea few large European marketplayerscharacterised by very high transaction volumeswill play a criticalrolefor the functioningof financial markets.Consequently, financial institutionswill be highlyexposed to potentialproblemsin a CCP.Also, proceduresin caseof a CCP distress(recapitalization, bail-inprocedures) remain unclear.Harmonisedresolution and recovery regimesfor CCPsacrossthe EUwouldhelp avoidingpotential regulatoryarbitrageand thuspreventingcustomer and taxpayer detriment.Solvency ii Associationwww.solvency-ii-association.com
  133. P a g e | 1335RISKSTO CONFIDENCE IN BALANCE SHEETVALUATIONSAND RISK DISCLOSURESThefinancial crisishasledtoa lossof confidencein the balancesheetvaluation and risk disclosuresof financial institutions.This is clearlyevidenced by the lowequitymarket valuationsof financialinstitutions,with many tradingsignificantlybelowtangiblebook value.In order topre-empt thosepressures,financial institutionsshould valueall their assetsand liabilitiesproperly, in full accordancewithapplicableaccountingstandardsand regulations,toensure valuation consistencywithin theEU.Institutionsshould analyse and understand thesourcesof valuationuncertainty, usingprudent valuation methodologies, and share thesewith supervisorsand potentiallyin publishedriskdisclosures.This callsfor consistencyin the approachestaken in bankingandinsuranceregulation.Aparticular problem for the insurancesector (due todelaystoIASBconvergenceworkand SolvencyII) is thecontinued absenceof EU-harmonised accountingstandardsand regulatory valuation rules,and inparticular thewidevariabilityin accountingfor insurancecontractliabilitiesand holdingsof lessliquid securities,such ascorporate bonds.For banks, the valueof their assets(and in the end their level of capital)is directlylinkedtothe economicsituationof the borrowersand theirabilityto repaytheir loans.As the number of borrowers in financial difficulty increases duringperiods of macro-economic weakness, banks may choose to offer acertainrelaxationof termsof the contract (forbearance).Solvency ii Associationwww.solvency-ii-association.com
  134. P a g e | 134This wouldavoid an actual or prospectivebreach of the original termsofthecontract.Thelow interestratesalsoprovidedirect and indirect incentivesforforbearance,asdiscussedin section 2.2.Forbearancemay disguisethe actual credit riskof individual banksand lead to theoverestimation of itscapital and resilience.Therisk that banksmay not haveadequatelyprovisionedagainst likelyfutureimpairmentsisalsoa source of uncertaintysurroundingaccountingvaluationsof banks‘balancesheets.Individual problemsof this kind can easilyreducethe trust in otherfinancial companies and increasesystemic risk.In addition, theassociatedrisk delaysthe necessaryde-leveragingofhouseholdsand non-financial corporatesand constrainslendingto moreproductiveborrowers,consequentlydelaying recovery.Existingloanstoborrowerswithquestionablelong-term viability mayalsotie up capital and funding and limit financial institutions‘ability toprovidecredit to new borrowers,distortingthe market allocationofcredit.Supervisorsand policymakershave toensure a common understandingof forbearance acrossEurope.Astep in this direction wasachievedin December 2012whenESMAissueda public statement on the treatment of forbearancepracticesintheIFRS financial statementsin whichit suggested a commondefinitionof forbearanceand pointed out to therelated measurementanddisclosurerequirementsof IFRS.The EBA is in an advanced stage of identifying a common definition forforbearance, aiming at providing supervisors with a tool to monitor assetqualitydevelopment in a coordinatedfashionand on a comparable basis.Solvency ii Associationwww.solvency-ii-association.com
  135. P a g e | 135Authoritieswill have to design thepath totheexit of the situationbyestablishingthe appropriaterhythm of cleaningthe balancesheets.At the same time, banks‘governanceof such apractice will have tobecloselymonitored and evaluated.This valuationuncertaintyaffectsnot onlybanking book loanportfoliosbut alsotrading book holdingsof securities, wherefair-valuepointestimatesof theexpectedre-salevalueof securitiesdonot capture thevaluation uncertaintyin lessliquid market conditions.One potential remedyis prudent valuations,basedon a higherconfidenceinterval for the re-salevalue of the securitiesValuationandrisk measurement – especiallyfor complex financial instrumentsand forlonger term (e.g. actuarial) risks – isgenerallybased on quantitativemodels.For assetsand riskswhere financial institutionsusesimilar or identical(external) models, theyare consequentlyexposedtovaluationrisksstemmingfrom model failures, imperfect calibrations,inappropriatemodellingchoicesand diverging decisionsof supervisorsin respect ofmodel approvals.Similar methodologicalrisks exist in the valuation of goodwill, i.e. thevalueof intangibleassetswitha quantifiablevalue.Theseare specific examplesof exposure to a common risk factor, in thisinstanceexposure tomodel parameter risk.This report hasalreadydiscussedseveral other examplesof financialinstitutions‘significant exposurestocommon risk factors, such asmacro-economic risk (Section 1), interest rate risk(Section 2) andcollateral risk (Section 4).Financial institutionsshould stresstest their businessplanscomprehensivelyagainst a range of scenarios for thosemain commonrisk drivers, includinginterestrates(lowfor longer or suddenadjustment), latent credit riskand legacyredressand litigationcosts.Solvency ii Associationwww.solvency-ii-association.com
  136. P a g e | 136Such forward-lookingstresstestsshouldbe used by financial institutionstodevelop crediblemanagement actionsto mitigatethe risks,and byfinancial regulatorstoinform supervisoryjudgmentsabout requirementsfor capital or management action.6 RISKOF LOSSOF CONFIDENCE IN FINANCIALBENCHMARKSFinancial market referenceratesand their calculationprocedureshaverecentlycome under closepublic scrutiny.Especiallyin the area of reference ratesfor unsecured inter-banklending, recent events13 have led to a weakeningof the credibilityofreferencerate systems in the EU and beyond.TheESAs areconcerned by theweakeningof thecredibilityof referencerate systemsand have taken an immediateinterest in this issue, giventheseriousflawsin the wayinter-bank interest rate benchmarks arebeingset, and their widespreadusein securities and other financial markets,and potential implicationsfor market integrity.Consequently, ESMAand EBA recentlytook decisiveaction, incoordinationwiththeEuropean Commission and IOSCO, to contributetoaddressingtheseflawsin theintervening period until a formalregulatoryand supervisoryframeworkisin force in the EU.Inter-bank referencerates– in particular thosecalculatedwithin the EU,such asLibor and Euribor – are themost widely-used reference ratesintheEuropean and global financial markets.Theyprovide thebasisfor the specificationof contractsin key marketsworldwide, includingforwardrate agreements,short-term interestratefuturescontracts,interestrate swaps,inflationswaps,floatingrate notes,syndicated loansand variablerate loansand mortgages, but alsoplay arolein currency tradingand in thecalculation of benchmarksand hurdleSolvency ii Associationwww.solvency-ii-association.com
  137. P a g e | 137ratesfor managed funds, includingmoney market funds, and privateequityfunds.Accordingtotheir widespreaduse, the value of financial contractsbasedon inter-bank referenceratesishigh, underliningthe centralityandimportanceof well-defined, robust, and crediblebenchmarks.Libor hasbeen estimatedtobe utilised asa referenceratefor USD 500trtoUSD 600tr in notional interest-ratederivativescontractsalone.Other benchmark ratesand their usesincluded, the total volume ofdependent contractsis likely tobe substantiallyhigher.From theperspectiveof cross-sectoralsystemic risksin theEU, theproblemsassociatedwithbenchmarksmay pose considerablechallenges,resultingfrom their potential impact on thecontinuityofsuch systems.Any disruption in theprovisionof suchreferenceratesmay naturallyhavefar-reachingconsequencesfor the financial instrumentsand entiremarketsrestingon their availability.Such disruptionsmay result from a lack of liquidityof the market onwhicha transactions-basedbenchmark draws,or the non-availability ofsufficient quotestocalculatea reporting-basedbenchmark.Recently, inter-bank reference systems such asEuribor-EBF haveexperienced withdrawalsby banksfrom their panels, reflectingtheirgrowingconcernsover litigationor politicalconsequencesofmisconduct aspanel contributors.No concreteindicationof an imminent waveof withdrawalsfromreporting panelscan be discerned at thetime of writing.However, herding logic in combinationwith a risingpotential burdenassociatedwithpanel contributionsmay in adverse circumstancestrigger an exodusfrom reportingpanels.Solvency ii Associationwww.solvency-ii-association.com
  138. P a g e | 138TheEuropean Commission‘sintentiontoproposethe mandatoryparticipationof bankswithinreportingpanels, whichis alsosupportedbythe ECB, hasthepotential tocorrect for thoseincentives.Any critical situation may be complicatedby the fact that there is nopractical experiencewith benchmark continuityissues.In addition, there iscurrentlynodesignatedsupervisoryauthority totakeownership in a critical situation around Euribor-EBF referencerates.Finally, there is a marked lack of contingencyplanning amongbenchmark providersaswell asusersfor such situations.Theinitiativestaken by EBA and ESMA on 11January 2013should becontinued, and theEuropean Commission should be encouragedtoinitiatelegislationaimed at providinga regulatory and supervisoryframeworkfor benchmarksin theEU.In particular, thecontinuityrisksdiscussedabove strongly suggest that afutureregulatoryframeworkshould require:- Contingencyplanning by benchmark providersand users,and inrelevant financial contracts.In addition, theremay beneed for:- Enforcement powerson thepart of competent authoritiesenablingthem to mandate contributorstomaintain their commitment tocertain benchmark system at timesof distressIn addition, competent authoritiesshould take intoconsideration intheir on-goingsupervisorywork, for exampleon implementingcapitaland liquidityrequirements,any potential effectson the incentivesforcontributorsto maintaintheir commitment tobenchmark panels.ESMA and EBA will continuetheir surveillanceof benchmark activitiesin theEU, and their contribution toregulatoryand supervisory activityin this area.Solvency ii Associationwww.solvency-ii-association.com
  139. P a g e | 139Consumer concernsand redresscoststhat some financial institutionsfaceasa consequenceof past businessconduct practisescan lead to financialstabilityimplicationsnot only becauseof potentiallyhighfines,compensation paymentsand legal costsarisingfor theseinstitutions,but alsothrough generallygrowingmistrust in the financialsector.Solvency ii Associationwww.solvency-ii-association.com
  140. P a g e | 140EIOPA Guidelinesonpreparing for Solvency IIOn 27 March2013theEuropean InsuranceandOccupational PensionsAuthority (EIOPA) published itsConsultationson Guidelineson preparingfor SolvencyII along witha cover notetobereadin conjunction with theconsultations.Theguidelinescover four areasof SolvencyII:- Systems of Governance (SoG);- Forward-lookingassessment of theundertaking‘s ownrisks(basedon theprinciplesof theOwnRiskand SolvencyAssessment(ORSA));- Submissionof informationto National Competent Authorities(NCAs); and- Pre-applicationfor internal models.TheEIOPA consultationsclose on 19June 2013.Final versionsof theguidelinesare expected to be publishedin Autumn2013,and are intendedto support both NCAs and firms in theirpreparationsfor SolvencyII.NCAs will have tonotify EIOPAwhether or not theywill complywitheach of the guidelines,withreasonsfor non-compliance, within twomonthsof publication.Theguidelinesare expectedtoapplyfrom 1January 2014.Solvency ii Associationwww.solvency-ii-association.com
  141. P a g e | 141TheEuropean processSolvencyII is beingcreated with a four-level process, whichbeganasthe"Lamfalussyprocess".This is an approach tothedevelopment of financial servicesregulationsused by the European Union.Originallydeveloped in March 2001,theprocessis named after thechairof the EU advisorycommitteethat created it, Alexandre Lamfalussy.It is made up of four "levels", each focusingon a specific stageof theimplementationof legislation.Level 1: The European Commission adoptsthe formal proposal fordirective/regulation.TheEuropean Council and European Parliament then adopt thelegislativeact.The Level 1Directive text wasadopted by the European Parliament on22 April 2009, endorsed by the Council of Ministers on 5 May 2009 andformallyadopted by the European Council on 10November 2009.Level 2: In areasspecified at Level 1,theCommissionproposesdelegatedactsand implementingacts.EIOPA hasprovided advice on the former, and is currentlyinvolved indraftingthe latter in the form of technical standards.Level 3: EIOPApublishes"complyor explain" guidelines.Level 4: Strengthened enforcement (by EIOPA and the EuropeanCommission).Solvency ii Associationwww.solvency-ii-association.com
  142. P a g e | 142Short DirectiveAshort amending Directivewasadopted on 3 July. Thismeansthat theoriginal implementationdate of 1November 2012in the SolvencyIIDirectivehaschanged.Sonow Member Stateshave until 30June 2013totransposetheDirectiveand firmshaveuntil 1January2014toimplement it.OmnibusIITheOmnibusII Directivewasproposedin January 2011by theEuropean Commission.It amendstheSolvencyII Directive, bringingit in linewiththeEuropean Union‘sLisbon Treaty.It hasalsobeen revisedtoreflectthe new supervisorystructure andpowerswithinthe European Union.OmnibusII amendstheSolvencyII Directivein three main areas:- Theproposal introducesa number of powersand responsibilitiesfortheEuropean Insuranceand Occupational PensionsAuthority(EIOPA).- Theproposal alsointroducestargeted changestothe SolvencyIIDirective, and givesthe European Commission broad powerstodefineLevel 2 specific transitional arrangementsthat should applytotheSolvencyII Directive.- Omnibus II is expected to maintain bifurcation of the Directive,which was formally introduced by the short amending Directiveadopted on 3 July2012.Under bifurcation, responsibilitiesof national supervisory authoritiesand EIOPAare switchedon at 30June 2013(ie transpositionwouldSolvency ii Associationwww.solvency-ii-association.com
  143. P a g e | 143havetobe completeby 30June 2013), and SolvencyII requirementsare switchedon for firmsfrom 1January 2014.In the interveningperiod firmswouldcontinueto be regulated undertheexistingregime and wouldbe abletocompletethe necessaryapproval processes(eg internal models, ancillaryown funds), whilesupervisorscontinue to assessfirm preparednessfor thenew regime.Theproposal doesnot mean that there will be transitional periodsin alltheareasmentionedor that the maximum period allowedfor will beapplied.It alsodoesnot mean there will be a delay of up toten yearsfor theimplementationof the Directive.TheCommission hasbeen very clearthat there wasand remainsnosuchintentionand that itsintended implementationdate is 1January 2014.Discussionscontinue at the European level on OmnibusII. Once theseare finalised the Commissionwill be ableto publiclypropose itsLevel 2drafting, and thisshould includemore detail on specific transitionalmeasures.The pillarsand requirementsPillarsare definedby EIOPAasa wayof grouping SolvencyIIrequirements(the concept of pillarsis not described in theDirective).SolvencyII is split intothree pillars,though Pillars2 and 3 are oftenreferredtogether asPillar 5 dueto the synergies betweenthem.Pillar 1covers financial requirements. This pillar aimsto ensure firms areadequately capitalised with risk-based capital. All valuations in this pillarare tobe done in a prudent and market consistent manner.Pillar 2 imposeshigher standardsof risk management and governancewithin thefirm. It givessupervisorsgreater powersto challengetheirfirms on risk management issues.Solvency ii Associationwww.solvency-ii-association.com
  144. P a g e | 144TheOwn Risk and SolvencyAssessment requires a firm toundertake itsownforward-lookingself-assessment of its risks, corresponding capitalrequirementsand adequacyof capital resources.Pillar 3 aims for greater levelsof transparencyfor supervisorsand thepublic. There isa privateannual report tosupervisors,and apublicsolvencyand financial conditionreport that increasesthe level ofdisclosurerequired by firms.Current returnswill be completely replacedby reportscontainingcoreinformation that firmswill have to provide on a quarterlyand annualbasis.This will ensure that, overall, there is better and more up-to-dateinformation on a firm‘s financial position.Solvency ii Associationwww.solvency-ii-association.com
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  153. P a g e | 153DisclaimerThe Association tries to enhancepublic accessto information about risk andcompliancemanagement.Our goal is to keep this information timely and accurate. If errorsarebrought to ourattention, wewill tryto correctthem.This information:- is of a general nature only and isnot intended to addressthe specificcircumstances of any particular individual or entity;- should not be relied on in the particular context of enforcement or similarregulatoryaction;- is not necessarily comprehensive, complete, or up to date;- is sometimeslinked to external sites over which theAssociation has nocontrol and for which theAssociation assumesno responsibility;- is not professional or legal advice (if you need specific advice, you shouldalwaysconsult a suitably qualified professional);- is in no wayconstitutive of an interpretative document;-doesnot prejudge the position that the relevant authorities might decideto take onthe same mattersif developments, including Court rulings, wereto lead it to revisesomeof the viewsexpressedhere;-doesnot prejudge the interpretation that the Courts might place on themattersat issue.Pleasenote that it cannot be guaranteed that theseinformation and documentsexactly reproduce officially adopted texts.It isour goal to minimize disruption causedby technical errors.However somedataor information mayhave been createdor structuredin filesor formats that are noterror-free and wecannot guaranteethat our service will not be interrupted orotherwiseaffectedby such problems.The Association acceptsno responsibility with regard to such problemsincurred asaresult of using this site or any linked external sites.Solvency ii Associationwww.solvency-ii-association.com
  154. P a g e | 154Solvency II SpeakersBureauTheSolvencyII Association hasestablishedthe SolvencyII SpeakersBureau for firmsand organizationsthat want to accesstheexpertiseofCertified Solvencyii Professionals(CSiiPs) and Certified SolvencyiiEquivalenceProfessionals(CSiiEPs).TheSolvencyII Association will be theliaison betweenour certifiedprofessionalsand theseorganizations,at no cost. We stronglybelievethat this can be a great opportunity for both, our certified professionalsandtheorganizers.Tolearnmore:www.solvency-ii-association.com/ Solvency_II_Speakers_Bureau.htmlSolvency ii Associationwww.solvency-ii-association.com
  155. P a g e | 155Course TitleCertified Solvency ii Professional (CSiiP):Preparing for the Solvency ii Directive of the EU (3 days)Objectives:This coursehasbeen designed toprovidewiththe knowledgeand skillsneeded to understand and support compliancewiththeSolvencyiiDirectiveof theEuropean Union.TargetAudience:This course isintendedfor decision makers, managers, professionalsand consultantsthat:A.Work in Insuranceor Reinsurancefirmsof EEAcountries.B.Work in Groups- Financial Conglomerates(FC), Financial HoldingCompanies(FHC), MixedFinancial Holding Companies (MFHC),InsuranceHolding Companies(IH C) - providing insuranceand/ orreinsuranceservicesin the EEA, whoseparent islocated in acountry oftheEEA.C.Want tounderstand thechallengesand the opportunitiesafter theSolvencyii Directive.This course ishighlyrecommendedfor supervisorsof EEA countriesthat want to understand how countriesseeSolvencyII asa CompetitiveAdvantage.This course is also recommended for all decision makers, managers,professionals and consultants of insurance and/ or reinsurance firmsinvolvedin risk and compliancemanagement.About the CourseSolvency ii Associationwww.solvency-ii-association.com
  156. P a g e | 156INTRODUCTIONTheEuropean Union‘sLegislativeProcessDirectivesand RegulationsTheFinancial ServicesAction Plan (FSAP) of theEUExtraterritorialApplication of European LawExtraterritorialApplication of the SolvencyII DirectiveSolvencyii and theLamfalussyProcessLevel 1: FrameworkPrinciplesLevel 2: Detailed Technical MeasuresLevel3: StrengtheningCooperationAmong RegulatorsLevel 4: EnforcementWeaknessesof SolvencyIFrom SolvencyI toSolvencyIISolvencyii PlayersSolvencyii ObjectivesTHE SOLVENCY II DIRECTIVEAUnified LegislativeBasisfor Prudential Regulation of InsurersandReinsurersRisk-BasedCapitalAllocationScope of theApplicationImportant DefinitionsValue-at-Riskin SolvencyIIAuthorisationCorporateGovernanceGovernanceFunctionsRiskManagementCorporateGovernanceand Risk Management - Level 2Fit and proper requirementsfor personswhoeffectivelyrun theundertakingor haveother key functionsInternal ControlsInternalAuditActuarial FunctionSolvency ii Associationwww.solvency-ii-association.com
  157. P a g e | 157OutsourcingBoard of Directors:Role and Solvencyii Responsibilities12Principles– System of Governance (Level 2)PILLAR 2SupervisoryReview Process(SRP)Focuson Risk Management and Operational RiskOwn Risk and SolvencyAssessment (ORSA)ORSA- TheInternal Assessment ProcessORSA- TheSupervisoryToolORSA- Not a Third Solvency Capital RequirementCapital add-onPILLAR 3DisclosureRequirementsTheSolvencyand Financial Condition Report (SFC)PILLAR IValuationOf AssetsAnd LiabilitiesTechnicalProvisionsTheSolvencyCapital Requirement (SCR)TheValue-at-RiskMeasureCalibratedtoa 99.5% ConfidenceLevel over a 1-year Time HorizonTheStandardApproachTheInternal ModelsTheCollectionofAdditional HistoricalDataExternal DataThe Minimum Capital Requirement (MCR)Non-CompliancewiththeMinimum Capital RequirementNon-CompliancewiththeSolvencyCapital RequirementOwnFundsInvestment RulesINTERNAL MODEL APPROVALSolvency ii Associationwww.solvency-ii-association.com
  158. P a g e | 158CEIOPSLevel 2 - Testsand Standardsfor Internal ModelApprovalCEIOPSLevel 2 - The procedure tobe followedfor theapproval ofan internal modelInternal ModelsGovernanceGroup internal modelsStatistical qualitystandardsCalibrationand validationstandardsDocumentation standardsSOLVENCY II, GROUP SUPERVISION AND TH IRD COUNTRIESSolvencyI: SoloPlusApproachGroup Supervisionunder SolvencyIIRightsand dutiesof the group supervisorGroup Solvency - Methodsof calculationMethod1(Default method):Accounting consolidation-basedmethodMethod2 (Alternative method): Deduction and aggregationmethodParent UndertakingsOutsidethe Community - Verification ofEquivalenceParent UndertakingsOutsidethe Community - Absence ofEquivalenceThehead of thegroup isin theEEA and the third country regimeis not equivalentThehead of thegroup isin theEEA and the third country regimeis equivalentThehead of thegroup isoutsidethe EEAand the third country isnot equivalentThehead of thegroup isoutsidethe EEAand the third countryregimeisequivalentSmall and Medium-SizedInsurers:TheProportionalityPrincipleCaptivesand SolvencyIISolvency ii Associationwww.solvency-ii-association.com
  159. P a g e | 159EQUIVALENCE WITH SOLVENCY II AROUND THE WORLDSolvencyii and Countriesoutsidethe European EconomicAreaTheInternationalAssociation of InsuranceSupervisors(IAIS)TheSwissSolvencyTest (SST) and Solvencyii:Solvencyii and theOffshoreFinancial Centers(OFCs)Solvencyii and theUSASolvencyii and theUS NationalAssociation of InsuranceCommissioners(NAIC) - The Federal InsuranceOffice createdunder the Dodd-Frank Wall Street Reform and ConsumerProtectionAct in theUSA, and the ORSAin theUSAFROM THE REINSURANCE DIRECTIVE TO THE SOLVENCY IIDIRECTIVEDirective2005/ 68/ EC of 16November 2005on Reinsurance- TheReinsuranceDirective(RID)CLOSINGTheImpact of Solvencyii OutsidetheEEAProvidingInsuranceServicestotheEuropean ClientCompeting withBanksLearningfrom theBaselii FrameworkRegulatoryArbitrage:AMajorRisk for Countriesthat seeComplianceasan Obligation, not anOpportunityBasel II, Basel III, SolvencyII and RegulatoryArbitrageChallengesand Opportunities:What is nextRegulatoryShopping after SolvencyIITolearnmore about thecourse:www.solvency-ii-association.com/ Certified_Solvency_ii_Training.htmSolvency ii Associationwww.solvency-ii-association.com
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  161. P a g e | 161We are pleased to announce our updated Distance Learningand Online Certification programs:1.Certified Solvencyii Professional (CSiiP) DistanceLearning and OnlineCertification Program:www.solvency-ii-association.com/CSiiP_Distance_Learning_Online_Certification_Program.htm2.Certified Solvency ii Equivalence Professional (CSiiEP) DistanceLearning andOnline Certification Program:www.solvency-ii-association.com/CSiiEP_Distance_Learning_Online_Certification_Program.htmSolvency ii Associationwww.solvency-ii-association.com

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