Solvency ii News December 2012


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Solvency ii News December 2012

  1. 1. Solvency ii Association 1200 G Street NW Suite 800 Washington, DC 20005-6705 USA Tel: 202-449-9750 www.solvency-ii-association.comDear member,We will start from a very interestingspeech:Gabriel BernardinoChairman of EIOPAEIOPA – Reflecting on theachievements and preparing for the new challengesDistinguished Guests, Ladies andGentlemen,On behalf of EIOPA, I am delighted towelcome you to our second AnnualConference here in the Frankfurt CongressCenter.In particular it is my pleasure to welcome all our panellists andmoderators.I want to thank you all for coming and contributing to make this one ofthe reference conferences in the insurance and pension’s landscape.I would also like to thank the City of Frankfurt and the State of Hessen,for their welcome and support. _________________________________________ Solvency ii Association
  2. 2. EIOPA greatly enjoys being here in a city which is continuousl y gainingglobal importance as a focal point for regulation and supervision of thefinancial system.I look forward to continuing in a spirit of enhanced co)operation in thefuture.We are happy to keep this tradition of annual conferences.For us this is a very important way to maintain a constructive dialoguewith the insurance and occupational pensions stakeholders – to find outmore about your concerns, challenges and of course to answer yourquestions.The annual conference also represents a perfect opportunity for EIOPAto update you on our activities, on the achievements and the upcomingchallenges.I am pleased to see that many members of the EIOPA Board ofSupervisors and Stakeholder Groups are also attending the conferenceand I am sure that they are going to contribute to all the formal andinformal discussions that will take place today.I hope that all together we will make this day interesting and fruitful.In my opening speech today I will share with you some thoughts aboutthe issues at stake in each of the panel discussions and I will provide ashort reflection on the achievements of EIOPA and some of thechallenges ahead.Let me start by the Conference programme, which as usual reflects someof the most relevant issues that EIOPA has been focused on. _________________________________________ Solvency ii Association
  3. 3. PensionsWe will start with pensions because reshaping the European pensionssystem is one of the most challenging projects in the EU agenda, whichis very important for all the EU citizens without exception.The EU Commission has launched this year a white paper called “Anagenda for adequate, safe and sustainable pensions”, identifying anumber of initiatives to be taken in the coming years.In this document there is a clear recognition that complementary privateretirement savings have to play a greater role in securing the futureadequacy of pensions.This poses on all of us a great challenge and an enormous responsibility.We need to review the European pension’s regulatory framework toimprove the safety and affordability of private pensions and provideconfidence to consumers.This should be done by developing a risk)based approach to theregulation of retirement savings, encompassing a number offundamental elements:1. A realistic valuation of pension promisesAll occupational schemes throughout Europe should have sufficientresources to meet their promises under a reasonable, but realistic andtransparent, framework.We have abundant lessons from the consequences of ignoring theeconomic based value of assets, liabilities and the inherent risks.That is why we recommended for the IORP Directive review theapplication of such principles as the market consistent valuations and _________________________________________ Solvency ii Association
  4. 4. the inclusion of the actuarial value of all enforceable obligations of theIORP in the valuation.Taking due account of the diversity of IORPs, we proposed the conceptof a “holistic balance sheet” that will enable the consideration of thevarious adjustment and security mechanisms in an explicit way.This will allow a better understanding of the economic value of assetsand liabilities and will give an indication of where the risk is and whobears it.The “holistic balance sheet” should be seen as a prudential supervisoryassessment tool rather than a “usual” balance sheet based on generallyagreed accounting standards.2. A robust solvency regulationThe occupational pension’s solvency regime should be based on the“holistic balance sheet” and should incorporate appropriate periods forthe achievement of the funding targets, taking into account the nature ofthe promise, the duration of the liabilities and other elements like thesponsor support.It should also be sufficiently flexible to deal with short term volatility andavoid pro-cyclical behaviour, for example by using a corridor approachand allowing appropriate recovering periods.3. An enhancement of the governance requirementsGood governance is crucial for the members and beneficiaries of theoccupational pension schemes.It is essential that those who run IORPs are individuals of competenceand integrity, with respective education and work experience. _________________________________________ Solvency ii Association
  5. 5. IORPs should also be subject to robust internal and external controls inareas such as risk management, internal control and audit, appointmentsof a custodian and a depository.The Solvency II principles should be applied, taken into account dueproportionality.The regulatory framework should also give concrete incentives to goodrisk management.The use of modern risk management tools like diversification strategiesin asset allocation according to the duration of the liabilities, lifecycleapproaches, hedging techniques and protection against shortfall riskscan effectively provide sponsors and members of pension schemes betteroutcomes under a risk control environment.4. An increase in transparencyIt is crucial to maintain members and beneficiaries of pension fundsduly informed about their pension rights and prospectives.Furthermore, the move towards defined contribution (DC) schemes,where the risk is born by the members, poses new challenges in terms oftransparency.That’s why EIOPA’s advice recommends the introduction in the IORPDirective of a Key Information Document (KID) to be distributed topotential members containing a set of basic elements like risks, costs,charges etc.This will surely improve transparency.EIOPA is continuing its work on the occupational pension’s area byrunning a Quantitative Impact Study (QIS) exercise. _________________________________________ Solvency ii Association
  6. 6. The QIS exercise aims to assess the financial impact on IORPs ofvaluing assets and liabilities in the holistic balance sheet andintroducing a solvency capital requirement (SCR) under various policyoptions of the EIOPA’s Advice.We expect to finalize the report on the QIS findings in spring 2013.Finally, we should not forget that there is also a need to look at theindividual retirement savings in the EU.The current framework applicable to 3rd Pillar products is very muchfragmented with a number of different vehicles being subject to differenttypes of EU regulations.I believe that there are merits in developing an EU wide framework forthe activities and supervision of individual retirement savings,containing both prudential and consumer protection measures.Improving consumer information and protection is necessary to enhancecitizens’ confidence in financial products for retirement savings.In this context, I believe that we should explore the development of an“EU retirement savings product”.This product could be developed to finance individual or collectiveDC plans and should clearly differentiate from other types of investmentproducts by being focused on the long)term nature of their objective(retirement savings), avoiding the traps of the short term horizon.It should be based on a simple framework, allowing for reduced coststructures and be managed using robust and modern risk managementtools.It should rely on clear and transparent governance structures andprovide full transparency to its members and beneficiaries.It should have access to a European passport allowing for cross)borderselling. _________________________________________ Solvency ii Association
  7. 7. An EU certification scheme could give to EU citizens a certainty in thequality of all marketed “EU retirement savings products”.In my view these products could also play an important role in the EUeconomy by assuring a focus on long)term investments and, thus,fostering the sustainable growth.Insurance RegulationOur second panel session is dedicated to the insurance regulation.We called it “The Way Ahead” and I am sure that we will have athoughtful discussion not only on Solvency II but also on internationaldevelopments.The European Union is faced today with an outdated and fragmentedregulatory and supervisory regime on insurance.The Solvency I regime is not risk sensitive, contains very few qualitativerequirements regarding risk management and governance and does notprovide supervisors with adequate information on the undertaking’srisks.Consequently, national authorities have been introducing differentelements on their regimes in order to cope with market developments.Solvency II was built with the objective of an increased policyholderprotection, using the latest international developments in risk basedsupervision, actuarial science and risk management.Coming back to the basics, it is fair to say that Solvency II is based onfundamentally sound principles:• A total balance sheet approach and a market consistent valuation ofassets and liabilities in order to have a realistic basis for assessing risks; _________________________________________ Solvency ii Association
  8. 8. • Two capital requirements, MCR and SCR, assuring a risk basedcalculation but also a more robust and simpler floor designed forultimate supervisory action;• An overall level of prudence for the calibration of capital requirements;• The explicit recognition of risk diversification;• The possibility to use internal models after a process of validation bysupervisors that is focused not only on the quality of risk modelling butalso on the actual use of the model in the day to day business decisions;• An updated group supervision approach with the definition of a groupsolvency requirement and clear powers assigned to the group supervisor;• A robust system of governance, including the definition of a number ofkey functions;• An Own Risk and Solvency Assessment (ORSA) that is now consideredas the best practice at an international level;• EU harmonized templates for supervisory reporting;• Enhanced public disclosure.In the meantime the financial crisis had a number of consequences onthe discussions on Solvency II.Some of them were dealt early in the project, some are still creatinguncertainties on the final design and calibration of the regime.The huge market volatility proved to be a challenge in a marketconsistent regime, especially for long term guarantees.The sovereign crisis led to questions on the concept of the risk free rate. _________________________________________ Solvency ii Association
  9. 9. The changes in banking regulation make more important the role ofinsurers as providers of long-term bank funding.The low interest rate scenario is threatening some insurance businessmodels.Without diminishing all these challenges, I believe it is time to move on.This reform is important and is needed.In order to keep the momentum and to be consequent with all thefinancial and human resources already dedicated to this project both bysupervisors and the industry we need to move forward.So, what steps do we need to take?In first place we need a strong commitment from the EU politicalinstitutions towards the implementation of Solvency II.This should prompt the definition of a clear and credible timetable basedon a realistic assessment of the expected time needed to deliver thedifferent milestones of the regime.Secondly, we need to agree on a sound and prudent regime for thevaluation of long term guarantees.A regime that preserves the risk based economic approach on thevaluation and assessment of risk and that adequately captures thecharacteristics of certain long term liabilities with sufficiently predictablematchable cash flows.This should be viewed as an opportunity to continue to offer long termguarantees to consumers, but under a robust framework that would pricecorrectly any options embedded in the contracts. _________________________________________ Solvency ii Association
  10. 10. The new regime should not work as an incentive to maintainunsustainable practices and products that are already challenged by theeconomic reality.We welcome the role that the EU political institutions are willing toattribute to EIOPA on the assessment of the long term guaranteepackage and we hope to receive a clear mandate within the terms ofreference in order to start the assessment as soon as possible.Thirdly, even if a credible timetable will probably point out to animplementation date not earlier than 2016, it should be possible in aninterim phase to start to incorporate in the supervisory process some ofthe key features of Solvency II.EIOPA is exploring this possibility, based on its powers under theEIOPA Regulation.This interim phase should be coordinated by EIOPA in order to ensure aconsistent application throughout the EU.Solvency II has been viewed internationally as a reference in risk basedregulation of insurance.In that sense many countries have considered elements from Solvency IIwhile developing their own regimes.The lack of certainty about Solvency II implementation is challengingthe EU credibility in the international discussions.Financial StabilityOur third panel session will focus on financial stability and on the role ofinsurers.The crisis prompted a new look at systemic risk, including in theinsurance sector. _________________________________________ Solvency ii Association
  11. 11. The identification and regulation of Globally Systemically ImportantInsurers is currently being discussed under the umbrella of the FinancialStability Board and the International Association of InsuranceSupervisors (IAIS).EIOPA is keen to contribute to a robust identification process of G-SIIsand to develop appropriate regulatory and supervisory tools to deal withtheir characteristics.Traditionally, systemic risk was a banking concept.However, the recent crisis showed us that certain activities developedunder the insurance sector can also pose systemic risk.Insurance companies or groups that engage in non-traditional, or non-insurance, activities (for example: CDS, financial guarantees orleveraging assets to enhance investment returns through securitieslending) are more vulnerable to financial market developments and,importantly, more likely to amplify, or contribute to systemic risk.Of course, this assessment may change over time, depending on theinnovations and changes in insurance business models, especially in lifeinsurance, as well as in the complex interactions between insurancegroups and financial markets.We should be especially attentive to any kind of maturity transformationand leveraging occurring in the insurance sector.Also extremely relevant are the policy measures under discussion.In line with the FSB recommendations, the IAIS proposed measures onenhanced supervision, effective resolution and higher loss absorbency.I welcome this approach.We need to be clear and transparent on the objectives of the framework. _________________________________________ Solvency ii Association
  12. 12. If insurance groups heavily develop their business into non-traditional ornon-insurance activities than they should expect to be treated in relationto those businesses as if they were banks.We need to limit any potential incentive for typical banking risks to betransferred to the insurance sector because some stricter regulation ofsystemic risk is applied in the banking sector.As the development of the international approaches to deal withsystemic risk in insurance is closer to an end, EIOPA will proceed,according to its regulation, and in consultation with the ESRB, with thedevelopment of criteria for the identification and measurement ofsystemic risk that may be posed by insurance, reinsurance andoccupational pension’s institutions within the EU context.EIOPA’s achievements and challengesLet me finalize by sharing with you some of EIOPA´s achievements andhighlight a number of challenges ahead.In spite of the natural constrains on human and financial resources andthe huge challenges posed by the crisis, I believe that EIOPA has beenquite successful in delivering an ambitious plan covering all areasassigned to us by the European Law.I’ve already commented on the huge work developed by EIOPA on theregulatory side both on insurance and on occupational pensions.Let me now turn to supervision.EIOPA has an enhanced role as a member of the colleges of supervisors.We developed an Action Plan with concrete deliverables and timings forthe Colleges. _________________________________________ Solvency ii Association
  13. 13. This has clearly increased the consistency of the work of the colleges andimproved the exchange of information between supervisors.During this crisis EIOPA has been monitoring and assessing marketdevelopments on a permanent basis, by using efficiently the publicinformation available and collecting more granular information directlyfrom the national supervisory authorities, both through specificquantitative and qualitative queries and by dedicated visits by EIOPAstaff.This allowed us to reinforce the coordination of the EU supervisor’sactions, highlight particular risks and activities that need to be furthermonitored and overall to be better prepared in the case of adversedevelopments.On consumer protection, that was identified as one of EIOPA’spriorities, I am very proud to mention that our first set of Guidelines wasdeveloped in the consumer protection area.The Guidelines on complaints handling by insurers fill an importantregulatory gap at the EU level and are an important step towardspromoting more transparency, simplicity and fairness in the market forconsumer financial products and services.Furthermore we issued a Good Practices Report analyzing the disclosureand sale of variable annuities that identifies how consumer interests canbe better protected as regards the sales of this type of complex products.We have also published an initial overview of consumer trends in theEuropean insurance and occupational pensions sectors, identifying threekey consumer areas that are presently subject to further review andanalysis:(1) Consumer protection issues around payment protection insurance;(2) Increased focus on unit-linked life insurance products and _________________________________________ Solvency ii Association
  14. 14. (3) Increased use of comparison websites by consumers.On financial stability, I want to emphasize the development andpublication of EIOPA’s risk dashboard containing a set of quantitativeand qualitative indicators that help to identify and measure the evolutionof risk in the EU insurance market.EIOPA has also run a low-yield stress test for the insurance sector thatshowed that the insurance industry would be negatively affected if ascenario were to materialize where yields remain low for a prolongedperiod of time.In the international relations area, EIOPA has been quite active,performing Solvency II full equivalence assessments of the Swiss,Bermudan and Japanese supervisory systems and running gap-analysesof the regulatory regimes of 8 further countries that had expressed aninterest in being included in a transitional regime.Furthermore, EIOPA has dedicated a special effort to a project with theUS federal and state insurance authorities aimed to increase mutualunderstanding and cooperation with a view to promote businessopportunities, consumer protection and efficient supervision.The public report that identifyies in a factual way the main similaritiesand differences of the insurance regulatory and supervisory regimes inthe EU and in the US is a very important step forward.As you can see EIOPA has already made a significant impact in the EUregulatory and supervisory landscape.This was only possible because of the dedication of our staff and theexcellent contribution from experts coming from the NationalSupervisory Authorities.It is their knowledge, experience and dedication that allow us to fulfilour mandate and respond to an increasingly demanding environment. _________________________________________ Solvency ii Association
  15. 15. Furthermore, the continuous commitment and cooperation of themembers of the Board of Supervisors and Management Board was of theutmost importance in fulfilling our mission and vision.Paramount to our activity was also the constant involvement with theInsurance and Reinsurance Stakeholder Group and the OccupationalPensions Stakeholder Group.The exchange of views and the opinions from the Stakeholder Groupswere essential in the development of EIOPA’s work.Looking forward, I am convinced that in a few years the setting up of theEuropean Supervisory Authorities will be recognized as one of the mostfundamental reforms in the European financial sector coming from thefinancial crisis.The potential benefits from the creation of a single rule book are huge,both for stability and consumer protection within the internal market.Nevertheless, EIOPA is confronted with a number of importantchallenges.Let me mention three relevant ones:1. How to assure the consistency of supervisory practices?I firmly believe that the consistency of supervisory practices is asimportant as the single rule book.Only by assuring that day-to-day supervision of financial institutions isdone within a consistent framework, we can effectively contribute to anincreased level of protection of policyholders and beneficiaries in theEuropean Union.The single market requires it and EIOPA is committed to deliver it. _________________________________________ Solvency ii Association
  16. 16. A first step should be the development of a Supervisory Handbook thatwould work as a guidebook for supervision in Solvency II, setting outgood practices in all the relevant areas of supervision.This handbook will foster the implementation of a more consistentframework for the conduct of supervision. EIOPA is starting to work inthis area.On the institutional side we observe the evolution in the banking areawith the proposals to create a single supervisory mechanism for the Euroarea banks.As a truly convicted European I welcome this step.I also recognize that the insurance sector is in a different situation.Insurance is not banking.There are indeed fundamental differences on the risks and on thebusiness models.Nevertheless, I believe that it is fundamental to rely on the experience ofwhat has been already achieved by EIOPA under the current Regulationand to start a reflection on further tasks, powers and resources needed todeliver a truly consistent supervisory process and, in particular, to assurea more consistent oversight of cross-border insurance groups.In the short term EIOPA should be ready to play its challengingoversight role according to the Regulation, by conducting inquiries intoa particular type of financial institution, or type of product, or type ofconduct in order to assess potential threats to the stability of thefinancial system and make appropriate recommendations for action tothe competent authorities concerned.In order to perform this independent assessment in a transparent,efficient and risk-based way, EIOPA needs to reinforce its humanresources, should have access to the relevant individual information _________________________________________ Solvency ii Association
  17. 17. available to the national supervisors and also have direct access to theindividual institutions.In the medium term the evolution to a more European focusedsupervision for the EU cross-border insurance groups should also bediscussed, namely in face of the potencial arbitrage opportunitiescoming from the new supervisory reality in the banking sector.2. The power to ban or restrict financial activitiesOn the Consumer protection area I want to highlight the urgent need toinclude provisions in the insurance and pension Directives allowingEIOPA to ban or restrict financial activities as established in Article 9 ofthe EIOPA Regulation.This will assure an effective way to deal, for example, with situations offlawed product design or governance that could lead to severe consumerdetriment.Without these provisions EIOPA cannot fulfill its mandate as describedin the Regulation.3. Competence on 3rd Pillar pensionsIn the pensions area EIOPA’s mandate only covers occupationalpensions, the so called 2nd pillar.However, I believe that the implementation of the EU agenda foradequate, safe and sustainable pensions calls for a sufficient level ofregulation and supervision of personal pensions, the so called 3rd pillar.Consequently, EIOPA’s mandate should be extended to all 3rd pillarpensions. _________________________________________ Solvency ii Association
  18. 18. This is also recommended by EIOPA’s Occupational PensionsStakeholder Group in their comment to the Commission’s White paperon Pensions.Ladies and gentleman,My vision is to build up EIOPA as a modern, competent andprofessional organization that acts independently in an effective andefficient way towards the creation of a common European supervisoryculture.We are living extraordinary times and we should feel priviledged to bepart of this process.As Bob Dylan so nicely singed: The times they are a-changin.Thank you. _________________________________________ Solvency ii Association
  19. 19. Opinion of the European Insurance andOccupational Pensions Authority of oninterim measures regarding Solvency IILegal Basis1. This opinion is issued under the provisions of Article 29(1) (a) ofRegulation (EU) No 1094/2010 of the European Parliament and of theCouncil of 24 November 2010 (hereafter the ‘Regulation’) in conjunctionwith Directive 2009/138/EC of the European Parliament and theCouncil of 25 November 2009 on the taking-up and pursuit of thebusiness of Insurance and Reinsurance (hereafter Solvency II Directive).2. As established in Article 29(1) (a) of the Regulation, EIOPA shall playan active role in building a common Union supervisory culture andconsistent supervisory practices, as well as in ensuring uniformprocedures and consistent approaches throughout the Union.3. As established under Article 1 (6) of the Regulation EIOPA shallcontribute to improving the functioning of the internal market, includingin particular a sound, effective and consistent level of regulation andsupervision, (Art. 1(6)(a)) preventing regulatory arbitrage and promotingequal conditions of competition (Art. 1(6)(d)). EIOPA shall alsocontribute to enhancing consumer protection (Art. 1(6)(f)).4. As established under Article 8 (1) of the Regulation EIOPA’s task is tocontribute to the establishment of high quality common regulatory andsupervisory standards and practices (Art. 1(6)(a)) and to contribute to theconsistent application of legally binding Union acts ensuring consistent,efficient and effective application of the acts referred to in Art. 1 (2) ofthe Regulation (Art. 1(6)(b)).The fact that the Solvency II Directive has entered into force, means thatit is considered “Union law”, but it will not have legally binding effectuntil after the date of its application, which is currently set to 1 _________________________________________ Solvency ii Association
  20. 20. January 2014 in accordance with the ("Quick Fix") Directive2012/23/EU of 12 September 2012.5. This opinion is addressed to the national competent authoritiesrepresented in EIOPA’s Board of Supervisors.Context6. During the Board of Supervisors (BoS) meeting of September 2012,Members expressed their strong concerns with respect to the currentstatus of the OMNIBUS II negotiations which might further delay theapplication of the Solvency II Directive.7. In its explanatory memorandum to the Proposal for the Solvency IIDirective the European Commission states:“The present solvency rules are outdated.They are not risk sensitive, they leave too much scope to Member Statesfor national variations, they do not properly deal with group supervisionand they have meanwhile been superseded by industry, international andcross-sectoral developments.This is the reason why a new solvency regime, called Solvency II, whichfully reflects the latest developments in prudential supervision, actuarialscience and risk management and which allows for updates in the futureis necessary.”8. In addition, in the absence of a final agreement on Solvency II,European supervisors may be forced to develop national solutions inorder to ensure sound risk sensitive supervision.Instead of reaching consistent and convergent supervision in the EU,different national solutions may emerge to the detriment of a goodfunctioning internal market. _________________________________________ Solvency ii Association
  21. 21. 9. The BoS mandated the Chair of EIOPA to write to the OMNIBUS IItrialogue parties setting out its concerns.In his letter, dated 4 October 2012, the Chair not only expressed the needfor a stable and reliable time plan but also the need to reflect on anearlier implementation of some Solvency II elements.{Note: Do you remember the letter?}Undertakings which are well-governed and which, in particular, measurecorrectly, mitigate and report the risks which they face will be morelikely to be prepared for the new regulatory framework and act in theinterests of policyholders. _________________________________________ Solvency ii Association
  22. 22. 10. In that regard it is of key importance that there will be a consistentand convergent approach with respect to the preparation of Solvency II.In the run-up to the new system the following key areas of Solvency IIneed to be addressed in order to ensure proper management ofundertakings and to ensure that supervisors have sufficient informationat hand.These are the system of governance, including risk management systemand a forward looking assessment of the undertakings own risks (basedon the ORSA principles), pre-application of internal models, andreporting to supervisors.11. EIOPA sets out below its expectations for the national competentauthorities.These actions are consistent with EIOPA’s obligation to fostersupervisory convergence.12. EIOPA will, taking into account its objective under Article 1 Para 6and its tasks and powers under Article 8 of the Regulation, contribute tothe consistent efficient and effective preparation of supervisors andinsurance and reinsurance undertakings for the application of theSolvency II Directive.13. As a follow-up to the opinion, and by making use of its powers underArticle 16 of the Regulation, EIOPA will publish guidelines addressed tonational competent authorities on how to proceed in the interim phaseleading up to Solvency II.14. Within 2 months of the issuance of the guidelines, each nationalcompetent authority shall confirm whether it complies or intends tocomply with the guidelines.In the event that a national competent authority does not comply or doesnot intend to comply, it shall inform EIOPA, stating its reasons. _________________________________________ Solvency ii Association
  23. 23. 15. EIOPA will publish the fact that a national competent authority doesnot comply or does not intend to comply with that guideline.Proposed actions by national competent authorities16. As part of the preparation for Solvency II, national competentauthorities should put in place, starting on 1 January 2014 certainimportant aspects of the prospective and risk based supervisoryapproach to be introduced in order to address the concerns set outabove.17. National competent authorities are expected to ensure that insuranceand reinsurance undertakings have in place an effective system ofgovernance which provides for sound and prudent management of theundertaking and an effective risk management system including aforward looking assessment of the undertakings own risks (based on theORSA principles).18. National competent authorities are expected to ensure that insuranceand reinsurance undertakings have in place an effective risk-management system comprising strategies, processes and reportingprocedures necessary to identify, measure, monitor, manage and report,on a continuous basis the risks, at an individual and at an aggregatedlevel, to which they are or could be exposed, and theirinterdependencies.19. National competent authorities are expected to review and evaluatewith respect to the undertakings concerned the system of governance,the assessment of the risks which those undertakings face or may faceand the assessment of the ability of those undertakings to assess thoserisks taking into account the environment in which the undertakings areoperating.20. Through internal model pre-application processes, nationalcompetent authorities engaged in pre-application of internal models _________________________________________ Solvency ii Association
  24. 24. should continue to work with undertakings to form a view onundertakings’ degree of readiness for internal model applications, andshould also follow subsequent evolutions to the internal modelframework.21. National competent authorities are encouraged to request all theinformation necessary for applying a prospective and risk basedsupervisory approach.22. National competent authorities are expected to ensure that therequirements mentioned above are applied in a manner which isproportionate to the nature, scale and complexity inherent in thebusiness of the insurance and reinsurance undertaking. _________________________________________ Solvency ii Association
  25. 25. Aruoba-Diebold-ScottiBusiness ConditionsIndexThe Aruoba-Diebold-Scotti business conditions index is designed totrack real business conditions at high frequency.Its underlying (seasonally adjusted) economic indicators (weekly initialjobless claims; monthly payroll employment, industrial production,personal income less transfer payments, manufacturing and trade sales;and quarterly real GDP) blend high- and low-frequency information andstock and flow data.The average value of the ADS index is zero. Progressively bigger positivevalues indicate progressively better-than-average conditions, whereas _________________________________________ Solvency ii Association
  26. 26. progressively more negative values indicate progressively worse-than-average conditions.The ADS index may be used to compare business conditions at differenttimes.A value of -3.0, for example, would indicate business conditionssignificantly worse than at any time in either the 1990-91 or the 2001recession, during which the ADS index never dropped below -2.0.The vertical lines on the figure provide information as to whichindicators are available for which dates.For dates to the left of the left line, the ADS index is based on observeddata for all six underlying indicators.For dates between the left and right lines, the ADS index is based on atleast two monthly indicators (typically employment and industrialproduction) and initial jobless claims.For dates to the right of the right line, the ADS index is based on initialjobless claims and possibly one monthly indicator. _________________________________________ Solvency ii Association
  27. 27. _________________________________________ Solvency ii Association
  28. 28. Financial services supervision: Commissionrequests Belgium, France, Greece,Luxembourg, Poland and Portugal toimplement EU rulesThe Commission has requested Belgium, France, Greece, Luxembourg,Poland and Portugal to notify within two months measures to implementEU rules in the financial sector (Directive 2010/78/EU) concerning thepowers of the three new European supervisory authorities for banks(European Banking Authority), insurance and occupational pensions(European Insurance and Occupational Pensions Authority) andsecurities (European Securities and Markets Authority).The Directive aims at adapting the provisions of key financial servicesDirectives to the new supervisory framework.This will make sure that European Supervisory authorities will be fullyallowed to carry out all the tasks conferred upon them.Member States were due to implement the Directive, no later than 31December 2011.The Commissions requests take the form of reasoned opinions underEU infringement procedures.If the Member States fail to notify measures to implement the Directivewithin two months, the Commission may decide to refer them to the EUCourt of Justice.Electronic money: Commission asks Court of Justice tofine Belgium for not implementing EU rulesThe European Commission has decided to refer Belgium to the Court ofJustice of the EU for failing to implement the Directive on the takingup, pursuit and prudential supervision of the business of electronicmoney institutions. _________________________________________ Solvency ii Association
  29. 29. The Commission has also decided to ask the Court to impose dailypenalty payments on Belgium, until it fully implements the Directive.The Commission proposes a daily fine of € 59 212,80 which would bepaid as from the date of the Courts ruling until Belgium notified theCommission that it had fully implemented the rules into national law. _________________________________________ Solvency ii Association
  30. 30. Basel 3 –The Timing DilemmaLast month the United States (US) regulatory authorities announced thatthey did not expect their rules implementing Basel 3 would becomeeffective on 1 January 2013, although they are working as “expeditiouslyas possible” to complete their rulemaking process.Similarly in the European Union (EU), the trilogue between theEuropean Commission, the European Parliament and the Council ofMinisters to agree the text of Capital Requirements Directive IV (CRDIV, the EU version of Basel 3 is still ongoing and, even if a politicalagreement can be reached by year-end (which still appears to be theintention), it is recognised in the EU that there will not be sufficient timefor CRD IV to be codified as legislation and put into effect on 1 January2013.So, does it necessarily follow that we should delay Basel 3implementation in Hong Kong because the US and the EU cannot meetthe internationally agreed timeline?Or should we follow the timeline set by the Basel Committee on BankingSupervision and begin the first phase of Basel 3 implementation from 1January 2013?Our Basel 3 rules (the Banking (Capital) (Amendment) Rules 2012) arecurrently tabled at LegCo and notwithstanding the expected delays inthe US and the EU, the Basel Committee’s timeline remains unchanged.Its gradual phase-in of the new capital standards over six years beginsfrom January 2013 and extends until 2019.In resolving the timing dilemma, it might first be instructive to remindourselves that Basel 3 is being introduced to rectify weaknesses made alltoo starkly apparent in the recent global financial crisis. _________________________________________ Solvency ii Association
  31. 31. Or, put another way, Basel 3 is considered good for financial stability.The Basel 3 capital standards are designed to strengthen banks’resilience by requiring more and better quality capital and by addressingand capturing risks not adequately recognised previously.The aim is to ensure that banks can weather future financial stormswithout disruption to their lending.This should in turn make them less likely to create or amplify problemsin other areas of the economy and facilitate their contribution to long-term sustainable economic growth.The roller-coaster of excessive leverage pre-crisis and excessivedeleveraging post-crisis is not conducive to sustainable growth.Regulation is all about balance.If regulation is too lax, excessive risk-taking may result with devastatingeffects.If regulation is too tight, it may suppress beneficial financial activity andreduce growth.In our view, Basel 3 represents an appropriate balance in bolsteringresilience whilst at the same time (with its extended phase-in) notunduly hampering lending to business and households today andensuring banks can continue to lend in any downturn tomorrow.For this reason we propose to begin implementing Basel 3 from 1January 2013.We are not alone in this.Our regional peers, Mainland China, Japan, Singapore and Australiahave all published their final rules for Basel 3 implementation next year. _________________________________________ Solvency ii Association
  32. 32. As has Switzerland, another important financial centre.But notwithstanding the intrinsic benefits of Basel 3, should wenevertheless be swayed by the argument put to us that Asia is taking the“medicine” designed for the countries worst affected by the crisis, whilstthe intended “patients” defer and thereby give their banks significant“competitive advantages” over our own?This competitive advantage argument would seem to be based on twoassumptions.First that US and EU global banks (i.e. those banks that couldrealistically compete with our own) are currently holding much lowerlevels of capital than required by Basel 3 (and hence will have a genuinecost advantage);and second that our banks will, come 1 January 2013, have to hold morecapital than they currently hold (and hence will incur additional cost).Are these assumptions correct?Well even though adoption of Basel 3 is delayed in the US and the EU,this certainly does not mean that banks in these regions remain at theirpre-crisis capital levels.There has been significant re-capitalisation.The Dodd Frank Wall Street Reform and Consumer Protection Act in theUS already requires the regulatory agencies to conduct stress-testingprogrammes to ensure banks and other systemically important financialinstitutions have enough capital to weather severe financial conditionsand, even before the passage of the Dodd Frank Act, the US FederalReserve Board put some of the largest US bank holding companiesthrough stress-tests, the results of which have led to significant increasesin capital.By 2012, the 19 bank holding companies subject to the Fed’sComprehensive Capital Analysis and Review had increased their _________________________________________ Solvency ii Association
  33. 33. aggregate tier 1 common capital to US$803 billion in the second quarterof the year from US$420 billion in the first quarter of 2009, with their tier1 common capital ratio (which compares high quality capital to assetsweighted according to their riskiness) doubling to a weighted average of10.9% from 5.4%.In the EU, under a recapitalisation exercise in 2011 that covered 71 of theEU’s major banks, the European Banking Authority (EBA) requiredmost to attain a “core tier 1 ratio” of not less than 9% by the end of June2012.In October 2012, the EBA indicated that it will focus on capitalconservation to “support a smooth convergence to the CRD IV…..regulatory requirements” and require the banks to maintain an absoluteamount of core tier 1 capital corresponding to the level of the 9% coretier 1 ratio.So even absent formal adoption of Basel 3, the capital levels of thelargest banks in the US and the EU have increased significantly post-crisis to levels comparable with, or even in excess of, those requiredunder Basel 3 and so the prospect of such banks “competing” by beingallowed to maintain much lower capital levels than Basel 3 banks wouldseem more apparent than real.Turning to the second “competitive” assumption, will the first phase ofBasel 3, which starts next year, require local banks to hold significantlymore capital than they do at present, to the extent that they may becomeconstrained in their ability to lend and compelled to pass on the costs ofthe extra capital to borrowers?Well, the results of the HKMA’s quantitative impact studies tell us thatour local banks are already very well-placed to meet the new Basel 3capital ratios.Their capital levels are already in excess of the standard taking effect on1 January 2013 and the issuance of ordinary shares (common equity)already accounts for a very significant proportion of their capital base, _________________________________________ Solvency ii Association
  34. 34. positioning them well for Basel 3’s new focus on common equity as thehighest quality capital for the purpose of loss absorption.In summary then, irrespective of any delay in formal implementation ofBasel 3, major banks in the US and EU are inexorably moving to higherlevels of capital.This, together with the benefits offered by Basel 3 and the relative easewith which local banks can comply, serves to underpin our view that weshould proceed to implement the first phase of Basel 3 in line with theBasel Committee’s timeline.Generally speaking, jurisdictions in Asia have in the past tended to adoptregulations that are in some respects higher than the Basel Committee’sminimum standards.This may have helped Asia weather the global financial crisis relativelyunscathed when compared with the jurisdictions worst affected.There would, therefore, seem little to be gained from seeking to engagein, or indeed prompt, a “race-to-the-bottom” in regulatory terms bydeliberately delaying the introduction of Basel 3 at this point in time.In implementing on 1 January 2013, we will be fulfilling our commitmentboth as an international financial centre which customarily adopts bestinternational standards and as a member of the Basel Committee onBanking Supervision.Karen KempExecutive Director (Banking Policy) _________________________________________ Solvency ii Association
  35. 35. Dear member,The regulatory arbitrage challenges and opportunities between thebanking and the insurance sector are always important and profitable formany, especially for consultants that are experts in both areas.For example, you can see an interesting job description:“Head of Risk & Compliance - Up to £200,000 package”The candidate needs to have strong expertise in the core RiskManagement areas like:- Compliance to Basel II, II.5 and Basel III- Compliance to Solvency IIYou can read more at: have to confess: I am a collector of ideas that lead to regulatoryarbitrage opportunities, especially between the banking and theinsurance balance sheet.Almost every financial product is subject to some form of supervisionand regulation, which is usually different in banking and insurance. Thisis an opportunity. The same product can be structured to become a“banking product” or an “insurance product”.I know. Basel iii and Solvency ii are supposed to eliminate regulatoryarbitrage opportunities.Every time I think something like that, I have to admit that firms (andcountries) will always do their best to exploit opportunities and havecompetitive advantages.This week I will start from an interesting phrase: _________________________________________ Solvency ii Association
  36. 36. “The changes in banking regulation make more important the role ofinsurers as providers of long-term ***bank funding***”Who said that?Gabriel Bernardino, the Chairman of EIOPA (the European Insuranceand Occupational Pensions Authority, one of three EuropeanSupervisory Authorities). _________________________________________ Solvency ii Association
  37. 37. Solvency II Speakers BureauThe Solvency II Association has established the Solvency II SpeakersBureau for firms and organizations that want to access the expertise ofCertified Solvency ii Professionals (CSiiPs) and Certified Solvency iiEquivalence Professionals (CSiiEPs).The Solvency II Association will be the liaison between our certifiedprofessionals and these organizations, at no cost. We strongly believethat this can be a great opportunity for both, our certified professionalsand the organizers.To learn _________________________________________ Solvency ii Association
  38. 38. Course Title Certified Solvency ii Professional (CSiiP): Preparing for the Solvency ii Directive of the EU (3 days)Objectives:This course has been designed to provide with the knowledge and skillsneeded to understand and support compliance with the Solvency iiDirective of the European Union.Target Audience:This course is intended for decision makers, managers, professionalsand consultants that:A. Work in Insurance or Reinsurance firms of EEA countries.B. Work in Groups - Financial Conglomerates (FC), Financial HoldingCompanies (FHC), Mixed Financial Holding Companies (MFHC),Insurance Holding Companies (IHC) - providing insurance and/orreinsurance services in the EEA, whose parent is located in a country ofthe EEA.C. Want to understand the challenges and the opportunities after theSolvency ii Directive.This course is highly recommended for supervisors of EEA countriesthat want to understand how countries see Solvency II as a CompetitiveAdvantage.This course is also recommended for all decision makers, managers,professionals and consultants of insurance and/or reinsurance firmsinvolved in risk and compliance management. _________________________________________ Solvency ii Association
  39. 39. About the CourseINTRODUCTION  The European Union’s Legislative Process  Directives and Regulations  The Financial Services Action Plan (FSAP) of the EU  Extraterritorial Application of European Law  Extraterritorial Application of the Solvency II Directive  Solvency ii and the Lamfalussy Process  Level 1: Framework Principles  Level 2: Detailed Technical MeasuresLevel 3: Strengthening Cooperation Among Regulators  Level 4: Enforcement  Weaknesses of Solvency I  From Solvency I to Solvency II  Solvency ii Players  Solvency ii ObjectivesTHE SOLVENCY II DIRECTIVE  A Unified Legislative Basis for Prudential Regulation of Insurers and Reinsurers  Risk-Based Capital Allocation  Scope of the Application  Important Definitions  Value-at-Risk in Solvency II  Authorisation  Corporate Governance  Governance Functions  Risk Management  Corporate Governance and Risk Management - Level 2  Fit and proper requirements for persons who effectively run the undertaking or have other key functions  Internal Controls _________________________________________ Solvency ii Association
  40. 40.  Internal Audit  Actuarial Function  Outsourcing  Board of Directors: Role and Solvency ii Responsibilities  12 Principles – System of Governance (Level 2)PILLAR 2  Supervisory Review Process (SRP)  Focus on Risk Management and Operational Risk  Own Risk and Solvency Assessment (ORSA)  ORSA - The Internal Assessment Process  ORSA - The Supervisory Tool  ORSA - Not a Third Solvency Capital Requirement  Capital add-onPILLAR 3  Disclosure Requirements  The Solvency and Financial Condition Report (SFC)PILLAR I  Valuation Of Assets And Liabilities Technical Provisions  The Solvency Capital Requirement (SCR)  The Value-at-Risk Measure Calibrated to a 99.5% Confidence Level over a 1-year Time Horizon  The Standard Approach  The Internal Models  The Collection of Additional Historical Data  External Data  The Minimum Capital Requirement (MCR)  Non-Compliance with the Minimum Capital Requirement  Non-Compliance with the Solvency Capital Requirement  Own Funds  Investment Rules _________________________________________ Solvency ii Association
  41. 41. INTERNAL MODEL APPROVAL  CEIOPS Level 2 - Tests and Standards for Internal Model Approval  CEIOPS Level 2 - The procedure to be followed for the approval of an internal model  Internal Models Governance  Group internal models  Statistical quality standards  Calibration and validation standards  Documentation standardsSOLVENCY II, GROUP SUPERVISION AND THIRD COUNTRIES  Solvency I: Solo Plus Approach  Group Supervision under Solvency II  Rights and duties of the group supervisor  Group Solvency - Methods of calculation  Method 1 (Default method): Accounting consolidation-based method  Method 2 (Alternative method): Deduction and aggregation method  Parent Undertakings Outside the Community - Verification of Equivalence  Parent Undertakings Outside the Community - Absence of Equivalence  The head of the group is in the EEA and the third country regime is not equivalent  The head of the group is in the EEA and the third country regime is equivalent  The head of the group is outside the EEA and the third country is not equivalent  The head of the group is outside the EEA and the third country regime is equivalent  Small and Medium-Sized Insurers: The Proportionality Principle  Captives and Solvency II _________________________________________ Solvency ii Association
  42. 42. EQUIVALENCE WITH SOLVENCY II AROUND THE WORLD  Solvency ii and Countries outside the European Economic Area  The International Association of Insurance Supervisors (IAIS)  The Swiss Solvency Test (SST) and Solvency ii:  Solvency ii and the Offshore Financial Centers (OFCs)  Solvency ii and the USA  Solvency ii and the US National Association of Insurance Commissioners (NAIC) - The Federal Insurance Office created under the Dodd-Frank Wall Street Reform and Consumer Protection Act in the USA, and the ORSA in the USAFROM THE REINSURANCE DIRECTIVE TO THE SOLVENCY IIDIRECTIVE  Directive 2005/68/EC of 16 November 2005 on Reinsurance - The Reinsurance Directive (RID)CLOSING  The Impact of Solvency ii Outside the EEA  Providing Insurance Services to the European Client  Competing with Banks  Learning from the Basel ii Framework  Regulatory Arbitrage: A Major Risk for Countries that see Compliance as an Obligation, not an Opportunity  Basel II, Basel III, Solvency II and Regulatory Arbitrage  Challenges and Opportunities: What is next  Regulatory Shopping after Solvency IITo learn more about the _________________________________________ Solvency ii Association
  43. 43. _________________________________________ Solvency ii Association