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Solvency II News, October 2012
Solvency II News, October 2012
Solvency II News, October 2012
Solvency II News, October 2012
Solvency II News, October 2012
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Solvency II News, October 2012

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Solvency II News, October 2012

Solvency II News, October 2012

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  • 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,Today we will start from a letter:EU to Gabriel Bernardino (EIOPA) _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 2. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 3. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 4. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 5. The new UK Regulator:The Financial Conduct AuthorityThe Financial Conduct Authority (FCA)will be the new regulator whose vision it is to make markets work well soconsumers get a fair deal.It will be responsible forrequiring firms to put the well-being of their customers at theheart of how they run theirbusiness, promoting effectivecompetition and ensuring thatmarkets operate with integrity.The FCA will start work in 2013,when it will receive new powersfrom the Financial Services Billthat is currently going throughparliament.The Journey to the FCA sets outhow we will approach ourregulatory objectives, how weintend to achieve a fair deal infinancial services for consumersand where we are on thisjourney.Changes to authorisationsThe UK regulatory structure will be changing in 2013, when the FSA willsplit into two regulatory bodies the Financial Conduct Authority (FCA)and the Prudential Regulation Authority (PRA).In April 2012, Supervision adopted the internal-twin peaks structure, andnow Authorisations are implementing a similar structure, with _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 6. assessments carried out by both the Prudential Business Unit (PBU) andthe Conduct Business Unit (CBU).This change will only affect firms that will be dual regulated in future.The application submission process will not change and we willcontinue to seek to meet our statutory deadlines.What will change is how the application is processed internally.There will be a CBU case officer and a PBU supervisor responsible foreach application and they will coordinate to minimise duplication or theimpact on applicant firms and individuals.The final decision will need to be agreed by both the PBU and the CBUto ensure a single FSA decision during transition to the new regulatorystructure.These changes will allow us to start to deliver, as far as possible, a modelthat will mirror the future authorisation procedures in the PRA and theFCA.What is happening to the FSA Handbook?At legal cutover, the FSA Handbook will be split between the FCA andthe PRA to form two new Handbooks, one for the PRA and one for theFCA.Most provisions in the FSA Handbook will be incorporated into thePRA’s Handbook, the FCA’s Handbook, or both, in line with each newregulator’s set of responsibilities and objectives.Users of the Handbook will be able to access the following online: 1. The PRA Handbook, displaying provisions which apply to PRA- regulated firms 2. The FCA Handbook, displaying all provisions which apply to FCA-regulated firms; and _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 7. 3. To support the transition, a central version which will show the provisions of both Handbooks, with clear labels indicating which regulator applies a provision to firms.The new Handbooks will reflect the new regulatory regime (for example,references to the FSA will be replaced with the appropriate regulator),and in some areas more substantive changes will be made to reflect theexistence of the two regulators, their roles and powers.(This is likely to include such aspects as the future processes forpermissions, passporting, controlled functions, threshold conditions andenforcement powers.)The more substantive changes will be consulted on before the PRA andthe FCA acquire their legal powers.Changes to the FSA Handbook as a result of EU legislation and FSApolicy initiatives will continue throughout this work.After acquiring their powers, the FCA and the PRA will amend their ownsuites of policy material as independent bodies in accordance with theprocesses laid down in the Financial Services Bill, including cooperationbetween them and external consultation.What does this mean for firms?This approach to the Handbooks for the FCA and the PRA has beenplanned to ensure a safe transition for firms and the new regulators asthe new regime is introduced.Firms will have a new regulator or regulators, and will consequently needto assess how the new Handbooks of these bodies will apply to them.Dual regulated firms will need to look to both the PRA and the FCAHandbooks, and FCA regulated firms to the FCA Handbook. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 8. When will the changes be in the Handbook?We expect to publish the new Handbooks before legal cutover.This will allow firms and others time to adjust to the application of thenew Handbooks before the FCA and the PRA are fully operational.The new Handbooks will not be available in detail before this.Alongside the publication, we will publish material on how to interpretthe application of the Handbooks, where this is not dealt with in theHandbooks themselves.The FSA will continue to make changes to its Handbook in accordancewith the normal procedure, until the new bodies acquire their legalpowers.The FSA Handbook will remain in force until the FCA and PRA acquiretheir legal powers. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 9. Launch of the Journey to the FCASpeech by Martin Wheatley - Managing Director,FSA, and CEO Designate, FCA at the Launch ofthe Journey to the FCA eventGood morning. I would like to thank the MinisterGreg Clark for joining us today, for his supportivewords – and for demonstrating the Government’s commitment toworking alongside us to deliver better conduct regulation. I would alsolike to thank Thomson-Reuters for hosting this morning.Today is a big step forward on the road to becoming the new regulator,and I am glad that you are all here to join us as we launch the Journey tothe FCA.The FCA offers a huge opportunity for the regulator and firms to startafresh, and work in partnership to reset how we deal with conduct infinancial services.We see it as the role of the regulator to not only make the relevantmarkets work well but also to help firms get back to putting theircustomers at the heart of how they do business.Regulation has a huge impact on the people and businesses that rely onfinancial services, and we should never forget this.We have approached the creation of the FCA in a thoughtful andconsidered way, as the document we are sharing with you today shows.We will regulate one of our most successful industries, central to thehealth of our economy and a provider of two million UK jobs.This makes our job an important one, and it will mean that we carry outour work in a way that is as open and accountable as possible.We spent the summer engaging with consumer organisations, and 500firms from all areas of financial services, as we developed our thinkingon the FCA. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 10. This allowed us to gather useful feedback and we will continue this openworking in the FCA.We aim in the Journey to the FCA to demonstrate what our neworganisation will mean for the firms we regulate and the consumers weare here to help protect.I encourage you all to read it, and to give us your views.We are clear about the type of regulator we want to become, and we wantto work with all of our stakeholders to get there and deliver regulationthat works better.You have not yet had a chance to read the document, so let me explain abit more about what the FCA is going to be about.The FCA has been set up to work with firms to ensure they putconsumers at the heart of their business.Underlining this are three outcomes:1. Consumers get financial services and products that meet their needsfrom firms they can trust.2. Firms compete effectively with the interests of their customers and theintegrity of the market at the heart of how they run their business.3. Markets and financial systems are sound, stable and resilient withtransparent pricing information.Reforming regulation is not just good for consumers, it will also be goodfor firms. The industry’s standing has suffered as the mis-sellingscandals and other problems have taken their toll.This has damaged the reputation of firms across the industry, whetherdirectly involved or not. We need to work with you to put that right.While much of what we will do is new, we will also build on what hasworked well under the FSA.We will keep up our policy of credible deterrence, pursuing enforcementcases to punish wrongdoing. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 11. And our markets regulation will continue to promote integrity and carryon the FSA’s fight against insider dealing, which has secured 20 criminalconvictions since 2009.We will continue to keep unauthorised firms from trying to takeadvantage of consumers.We will set high expectations for those firms that want to enter financialservices, while still allowing innovation and good ideas to flourish.And we will take forward a strong interest in the fair treatment ofcustomers – an agenda that has been around for many years, but is stillkey to the FCA.There will, however, be important changes, and our approach will bemore forward-looking, better informed, and we will have a greaterappetite to get things done.A new department will act as the radar of our new organisation –combining better research into what is happening in the market, andanalysis of the risks to our objectives.This will then feed into our policymaking and our supervision of firms.We want to really understand what is happening to your customers, thedeal they are getting and the issues they face.This will include getting a better understanding of why consumers act inthe way they do, so we can adapt our regulation to their commonbehavioural traits.Fewer firms will have regular direct contact with supervisors, as we shiftresources to allow us to deal more quickly and effectively with emergingissues, and run more cross-industry projects to get to the root cause ofproblems.We will have new partners to work with and our relationship with thenew Prudential Regulation Authority will be crucial, and driven by aculture of cooperation. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 12. We will aim to bring our expertise to international debates, so that EUand international policymaking works for UK consumers and firms.All of this will be delivered by a new culture in the FCA. We willencourage our staff to be more confident in making bold, firm andpredictable decisions.To help us do our job, the Government intends to give the FCA newtools to ensure that consumers get products that meet their needs.This builds on one of the key lessons from past problems, which is thatregulation is often more effective if it steps in early to pre-empt andprevent widespread harm.We will reflect this in our supervision work when we look at how firmsdesign and sell their products.But a key new power will mean that we can step in and ban the sale ofproducts that pose unacceptable risks to consumers for up to 12 months,without consulting first.We will also be able to ban misleading advertising.We will use these new tools in a measured way – and while we will actsooner, and more decisively, our approach will be based on a properunderstanding of the issues and a full consideration of the potentialsolutions.So whilst there may be times when we have to act rapidly, this is notsomething that firms should be afraid of.Firms selling the right products, in the right way, to the right consumershave little to fear.Our new approach will mean that we will take competition into accountin all our work.We will weigh up the impact on competition of new measures wepropose. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 13. We will also consider whether competition could lead to better resultsthan other action we could take.In our work here, and in other areas, I am very conscious that we have towork with firms.Making regulation work better for us is also about allowing firms roomto try new ideas and develop their business.Promoting competition will play an important part in this.We are not here to stand in the way of progress that will be of benefit toconsumers.Our goals as the FCA are clear: we will work for an industry that is betterat serving the needs of its customers.I see this as an opportunity – not just for us but for the industry.We can do our job better if we work with you, and I am pleased that somany of the chief executives that I speak to are talking the samelanguage and have committed to rebuilding confidence and trust, andreconnecting with their customers.It is great hearing about these good intentions, but the difficult bit for usall is to make sure this change actually happens.There are challenges and opportunities for both us the regulator, andyou the industry.It is a journey we have to walk together, as we put consumers back at theheart of what we do. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 14. Technical Specifications for theSolvency II valuation and SolvencyCapital Requirements calculations(Part I)NoteThis technical specification is a workingdocument proposed by EIOPA to be used by insurance and reinsuranceundertakings participating in any quantitative assessment to beundertaken until new update is available.As there are essential parts of the valuation framework still underpolitical discussions, i.e. the discount rates for the technical provisionscalculations, this document is not intended to be a complete set oftechnical specifications for the Solvency 2 balance sheet valuation nor forthe Solvency Capital Requirements calculations.Howsoever these essential parts are not included at this stage but willfollow in due course.Not even when the specification of discount rates for TP calculations arefinally added, the resulting technical specifications should be seen as acomplete implementation of the Solvency II framework, since for thepurpose of feasibility of testing exercises, shortcuts and ad hocsimplifications have been included.In particular, relevant parts of the SCR calculation such as internalmodels section, undertaking specific parameters section and within thegroup section: the combination method, the treatment of Participations,Ring Fenced funds and internal model for group calculation have beendeliberately not included in the current technical specifications, as thesewere not considered by EIOPA as providing key information for thepurposes of the quantitative tests that may be launched in the comingmonths. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 15. However, this should not be interpreted as an EIOPA speculation on itsinclusion in the final Solvency II framework.This technical specification is inspired by the knowledge that EIOPAhas on the current status of the negotiations on Omnibus 2 Directive, theworking documents on implementing measures and its own work in thedevelopment of Technical Standards and Guidelines.EIOPA plans to incorporate the relevant elements of the technicalprovisions valuation, once the outcome of the OMDII negotiations isstabilised.Important partsIAS 39 Financial Instruments: Recognition and MeasurementIAS 39 establishes principles for recognising and measuring financialassets, financial liabilities and some contracts to buy or sell non-financialitems.For the purpose of measuring a financial asset after initial recognition,this Standard classifies financial assets into the following four categoriesdefined in paragraph 9:(a) Financial assets at fair value through profit or loss;(b) Held-to-maturity investments;(c) Loans and receivables; and(d) Available-for-sale financial assets.These categories apply to measurement and profit or loss recognitionunder this Standard.The entity may use other descriptors for these categories or othercategorisations when presenting information in the financial statements. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 16. After initial recognition, an entity shall measure financial assets,including derivatives that are assets, at their fair values, without anydeduction for transaction costs it may incur on sale or other disposal,except for the following financial assets:(a) Loans and receivables, which shall be measured at amortised costusing the effective interest method(b) Held-to-maturity investments, which shall be measured at amortisedcost using the effective interest method(c) Investments in equity instruments that do not have a quoted marketprice in an active market and whose fair value cannot be reliablymeasured and derivatives that are linked to and must be settled bydelivery of such unquoted equity instruments, which shall be measuredat cost.Solvency II framework: Fair value measurement principles areconsidered to be consistent with article 75 of Directive 2009/138/EC,except for subsequent adjustments to take account of the change in owncredit standing of the insurance or reinsurance undertaking after initialrecognition in the measurement of financial liabilities.Technical ProvisionsIntroductionTP.1.1. The reporting date to be used by all participants should be 30June.TP.1.2. Solvency II requires undertakings to set up technical provisionswhich correspond to the current amount undertakings would have to payif they were to transfer their (re)insurance obligations immediately toanother undertaking. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 17. The value of technical provisions should be equal to the sum of a bestestimate and a risk margin.However, under certain conditions that relate to the replicability of thecash flows underlying the (re)insurance obligations, best estimate andrisk margin should not be valued separately but technical provisionsshould be calculated as a whole.TP.1.3. Undertakings should segment their (re)insurance obligationsinto homogeneous risk groups, and as a minimum by line of business,when calculating technical provisionsTP.1.4. The best estimate should be calculated gross, without deductionof the amounts recoverable from reinsurance contracts and SPVs. Thoseamounts should be calculated separately.TP.1.5. The calculation of the technical provisions should take accountof the time value of money by using the relevant risk-free interest rateterm structure.TP.1.6. The actuarial and statistical methods to calculate technicalprovisions should be proportionate to the nature, scale and complexity ofthe risks supported by the undertaking.V.2.1. SegmentationGeneral principlesTP.1.7. Insurance and reinsurance obligations should be segmented as aminimum by line of business (LoB) in order to calculate technicalprovisions.TP.1.8. The purpose of segmentation of (re)insurance obligations is toachieve an accurate valuation of technical provisions.For example, in order to ensure that appropriate assumptions are used, itis important that the assumptions are based on homogenous data to _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 18. avoid introducing distortions which might arise from combiningdissimilar business.Therefore, business is usually managed in more granular homogeneousrisk groups than the proposed minimum segmentation by lines ofbusiness where it allows for a more accurate valuation of technicalprovisions.TP.1.9. Undertakings in different Member States and even undertakingsin the same Member State offer insurance products covering differentsets of risks.Therefore it is appropriate for each undertaking to define thehomogenous risk group and the level of granularity most appropriate fortheir business and in the manner needed to derive appropriateassumptions for the calculation of the best estimate.TP.1.10. (Re)insurance obligations should be allocated to the line ofbusiness that best reflects the nature of the risks relating to theobligation.In particular, the principle of substance over form should be followed forthe allocation.In other words, the segmentation should reflect the nature of the risksunderlying the contract (substance), rather than the legal form of thecontract (form).TP.1.11. The segmentation into lines of business distinguishes betweenlife and non-life insurance obligations.This distinction does not coincide with the legal distinction between lifeand non-life insurance activities or the legal distinction between life andnon-life insurance contracts.Instead, the distinction between life and non-life insurance obligationsshould be based on the nature of the underlying risk:- Insurance obligations of business that is pursued on a similar technical basis to that of life insurance should be considered as life _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 19. insurance obligations, even if they are non-life insurance from a legal perspective.- Insurance obligations of business that is not pursued on a similar technical basis to that of life insurance should be considered as non- life insurance obligations, even if they are life insurance from a legal perspective.TP.1.12. In particular, annuities stemming from non-life insurancecontracts (for example for motor vehicle liability insurance) are lifeinsurance obligations.TP.1.13. The segmentation should be applied to both components of thetechnical provisions (best estimate and risk margin). It should also beapplied where technical provisions are calculated as a whole.Segmentation of non-life insurance and reinsurance obligationsTP.1.14. Non-life insurance obligations should be segmented into thefollowing 12 lines of business:Medical expenses insuranceThis line of business includes obligations which cover the provision ofpreventive or curative medical treatment or care including medicaltreatment or care due to illness, accident, disability and infirmity, orfinancial compensation for such treatment or care, where the underlyingbusiness is not pursued on a similar technical basis to that of lifeinsurance, other than obligations considered as workers compensationinsurance;Income protection insuranceThis line of business includes obligations which cover financialcompensation in consequence of illness, accident, disability or infirmitywhere the underlying business is not pursued on a similar technical basisto that of life insurance, other than obligations considered as medicalexpenses or workers compensation insurance; _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 20. Workers’ compensation insuranceThis line of business includes health insurance obligations which relateto accidents at work, industrial injury and occupational diseases andwhere the underlying business is not pursued on a similar technical basisto that of life insurance covering:- the provision of preventive or curative medical treatment or care relating to accident at work, industrial injury or occupational diseases; or- financial compensation for such treatment;- or financial compensation for accident at work, industrial injury or occupational diseases;Motor vehicle liability insuranceThis line of business includes obligations which cover all liabilitiesarising out of the use of motor vehicles operating on land (includingcarrier’s liability);Other motor insuranceThis line of business includes obligations which cover all damage to orloss of land vehicles, (including railway rolling stock);Marine, aviation and transport insuranceThis line of business includes obligations which cover all damage or lossto river, canal, lake and sea vessels, aircraft, and damage to or loss ofgoods in transit or baggage irrespective of the form of transport.This line of business also includes all liabilities arising out of use ofaircraft, ships, vessels or boats on the sea, lakes, rivers or canals(including carrier’s liability). _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 21. Fire and other damage to property insuranceThis line of business includes obligations which cover all damage to orloss of property other than motor, marine aviation and transport due tofire, explosion, natural forces including storm, hail or frost, nuclearenergy, land subsidence and any event such as theft;General liability insuranceThis line of business includes obligations which cover all liabilities otherthan those included in motor vehicle liability and marine, aviation andtransport;Credit and suretyship insuranceThis line of business includes obligations which cover insolvency, exportcredit, instalment credit, mortgages, agricultural credit and direct andindirect suretyship;Legal expenses insuranceThis line of business includes obligations which cover legal expensesand cost of litigation;Assistance insuranceThis line of business includes obligations which cover assistance forpersons who get into difficulties while travelling, while away from homeor while away from their habitual residence;Miscellaneous financial loss insuranceThis line of business includes obligations which cover employment risk,insufficiency of income, bad weather, loss of benefits, continuing generalexpenses, unforeseen trading expenses, loss of market value, loss of rent _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 22. or revenue, indirect trading losses other than those mentioned before,other financial loss (not-trading) as well as any other risk of non-lifeinsurance business not covered by the lines of business alreadymentioned.TP.1.15. Obligations relating to accepted proportional reinsuranceshould be segmented into 12 lines of business in the same way as non-life insurance obligations are segmented.TP.1.16. Obligations relating to accepted non-proportional reinsurancein non-life should be segmented into 4 lines of business as follows:- Health: non-proportional reinsurance obligations relating to insurance obligations included in the following lines: medical expenses, income protection and workers’ compensation.- Property: non-proportional reinsurance obligations relating to insurance obligations included in the following lines: other motor insurance, fire and other damage to property, credit and suretyship, legal expenses, assistance, miscellaneous financial loss. Casualty: non-proportional reinsurance obligations relating to insurance obligations included in the following lines: motor vehicle liability and general liability.- Marine, aviation and transport: non-proportional reinsurance obligations relating to insurance obligations included in the line marine, aviation and transport insuranceSegmentation of life insurance and reinsurance obligationsTP.1.17. Life insurance obligations should be segmented into 6 lines ofbusiness. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 23. Health insuranceHealth insurance obligations where the underlying business is pursuedon a similar technical basis to that of life insurance, other than thoseincluded in the following line of business “Annuities stemming fromnon-life insurance contracts and relating to health insuranceobligations”.Life insurance with profit participationInsurance obligations with profit participation other than thoseobligations included in the annuities stemming from non-life insurancecontracts.Index-linked and unit-linked insuranceInsurance obligations with index-linked and unit-linked benefits otherthan those included in the annuities stemming from non-life insurance.Other life insuranceobligations other than obligations included in any of the other life linesof business.Annuities stemming from non-life insurance contracts and relating tohealth insurance obligations (annuities stemming from non-lifecontracts and NSLT health insurance).Annuities stemming from non-life insurance contracts and relating toinsurance obligations other than health insurance obligationsTP.1.18. Obligations relating to accepted reinsurance in life should besegmented into 4 lines of business as follows: _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 24. Health reinsuranceReinsurance obligations which relate to the obligations included in linesof business health insurance and “Annuities stemming from non-lifeinsurance contracts and relating to health insurance obligations”.Life reinsuranceReinsurance obligations which relate to the obligations included in linesof business “Life Insurance with profit participation”, “Index-linked andunit-linked insurance”, “Other life insurance” and “Annuities stemmingfrom non-life insurance contracts and relating to insurance obligationsother than health insurance obligations”.TP.1.19. There could be circumstances where, for a particular line ofbusiness in the segment "life insurance with profit participation"(participating business), the insurance liabilities can, from the outset,not be calculated in isolation from those of the rest of the business.For example, an undertaking may have management rules such thatbonus rates on one line of business can be reduced to recoup guaranteedcosts on another line of business and/or where bonus rates depend onthe overall solvency position of the undertaking.However, even in this case undertakings should assign a technicalprovision to each line of business in a practicable manner.Health insurance obligationsTP.1.20. Health insurance covers one or both of the following:- The provision of preventive or curative medical treatment or care including medical treatment or care due to illness, accident, disability and infirmity, or financial compensation for such treatment or care; _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 25. - Financial compensation in consequence of illness, accident, disability or infirmity.TP.1.21. In relation to their technical nature two types of healthinsurance can be distinguished:- Health insurance which is pursued on a similar technical basis to that of life insurance (SLT Health)- Health insurance which is not pursued on a similar technical basis to that of life insurance (Non-SLT Health)TP.1.22. Health insurance obligations pursued on a similar technicalbasis to that of life insurance (SLT Health) are the health insuranceobligations for which it is appropriate to use life insurance techniquesfor the calculation of the best estimate.Health insurance obligations should be assigned to life insurance linesof business where such obligations are exposed to biometrical risks (i.e.mortality, longevity or disability/morbidity) and where the commontechniques used to assess such obligations explicitly take intoconsideration the behaviour of the variables underlying these risks.Where insurance or reinsurance health obligations are calculatedaccording to the conditions set out in Article 206 of Directive2009/138/EPC they should be assigned to SLT health insurance lines ofbusiness.TP.1.23. SLT health insurance obligations should be allocated to one ofthe four following lines of business for life insurance obligations definedin subsection V .2.1:- Insurance contracts with profit participation where the main risk driver is disability/morbidity risk- Index-linked and unit-linked life insurance contracts where the main risk driver is disability/morbidity risk _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 26. - Other insurance contracts where the main risk driver is disability/morbidity risk- Annuities stemming from non-life contracts.TP.1.24. With regard to the line of business for annuities stemming fromnon-life contracts or health insurance includes only annuities stemmingfrom Non-SLT health contracts (for example workers compensation andincome protection insurance).Insurance or reinsurance obligations that, although stemming fromNon-Life or NSLT health insurance, and originally segmented into Non-Life or NSLT health lines of business, as a result of the trigger of anevent are pursued on a similar technical basis to that of life insurance,should be assigned to the relevant life lines of business as soon as thereis sufficient information to assess those obligations using life techniques.TP.1.25. Non-SLT health obligations should be allocated to one of thethree following lines of business for non-life insurance obligations: - Medical expense- Income protection- Workers compensationTP.1.26. The definition of health insurance applied in the QuantitativeAssessment may not coincide with national definitions of healthinsurance used for authorisation or accounting purposes.TP.1.27. The granularity of the segmentation of insurance or reinsuranceobligations should allow for an adequate reflection of the nature of therisks.For the purpose of calculation of the technical provisions, thesegmentation should consider the policyholder’s right to profitparticipation, options and guarantees embedded in the contracts and therelevant risk drivers of the obligations. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 27. Unbundling of insurance and reinsurance contractsTP.1.28. Where a contract includes life and non-life (re)insuranceobligations, it should be unbundled into its life and non-life parts.TP.1.29. Where a contract covers risks across the different lines ofbusiness for non-life (re)insurance obligations, these contracts should beunbundled into the appropriate lines of business.TP.1.30. A contract covering life insurance risks should always beunbundled according to the following lines of business- SLT- Life insurance with profit participation- Index-linked and unit-linked life insurance- Other life insuranceTP.1.31. Where a contract gives rise to SLT health insurance obligations,it should be unbundled into a health part and a non-health part where itis technically feasible and where both parts are material.Notwithstanding the above, unbundling may not be required where onlyone of the risks covered by a contract is material.In this case, the contract may be allocated according to the main risk.Best estimateV.2.2.1. Methodology for the calculation of the best estimateAppropriate methodologies for the calculation of the bestestimateTP.2.1. The best estimate should correspond to the probability weightedaverage of future cash-flows taking account of the time value of money. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 28. TP.2.2. Therefore, the best estimate calculation should allow for theuncertainty in the future cash-flows.The calculation should consider the variability of the cash flows in orderto ensure that the best estimate represents the mean of the distributionof cash flow values.Allowance for uncertainty does not suggest that additional marginsshould be included within the best estimate.TP.2.3. The best estimate is the average of the outcomes of all possiblescenarios, weighted according to their respective probabilities.Although, in principle, all possible scenarios should be considered, itmay not be necessary, or even possible, to explicitly incorporate allpossible scenarios in the valuation of the liability, nor to develop explicitprobability distributions in all cases, depending on the type of risksinvolved and the materiality of the expected financial effect of thescenarios under consideration.Moreover, it is sometimes possible to implicitly allow for all possiblescenarios, for example in closed form solutions in life insurance or thechain-ladder technique in non-life insurance.TP.2.4. Cash-flow characteristics that should, in principle and whererelevant, be taken into consideration in the application of the valuationtechnique include the following:a) Uncertainty in the timing, frequency and severity of claim events.b) Uncertainty in claims amounts, including uncertainty in claimsinflation, and in the period needed to settle and pay claims.c) Uncertainty in the amount of expenses.d) Uncertainty in the expected future developments that will have amaterial impact on the cash in- and out-flows required to settle theinsurance and reinsurance obligations thereof (e.g. the value of anindex/market values used to determine claim amounts).For this purpose future developments shall include demographic, legal,medical, technological, social, environmental and economicdevelopments including inflation. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 29. e) Uncertainty in policyholder behaviour.f) Path dependency, where the cash-flows depend not only oncircumstances such as economic conditions on the cash-flow date, butalso on those circumstances at previous dates.A cash-flow having no path dependency can be valued by, for example,using an assumed value of the equity market at a future point in time.However, a cash-flow with path-dependency would need additionalassumptions as to how the level of the equity market evolved (the equitymarkets path) over time in order to be valued.g) Interdependency between two or more causes of uncertainty.Some risk-drivers may be heavily influenced by or even determined byseveral other risk-drivers (interdependence).For example, a fall in market values may influence the (re)insuranceundertaking’s exercise of discretion in future participation, which in turnaffects policyholder behaviour.Another example would be a change in the legal environment or theonset of a recession which could increase the frequency or severity ofnon-life claims.TP.2.5. Undertakings should use actuarial and statistical techniques forthe calculation of the best estimate which appropriately reflect the risksthat affect the cash-flows.This may include simulation methods, deterministic techniques andanalytical techniques.TP.2.6. For certain life insurance liabilities, in particular the futurediscretionary benefits relating to participating contracts or othercontracts with embedded options and guarantees, simulation may leadto a more appropriate and robust valuation of the best estimate liability. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 30. TP.2.7. For the estimation of non-life best estimate liabilities as well aslife insurance liabilities that do not need simulation techniques,deterministic and analytical techniques can be more appropriate.Cash-flow projectionsTP.2.8. The best estimate should be calculated gross, without deductionof the amounts recoverable from reinsurance contracts and specialpurpose vehicles.Recoverables from reinsurance and Special Purpose Vehicles should becalculated separately.In the case of co-insurance the cash-flows of each co-insurer should becalculated as their proportion of the expected cash-flows withoutdeduction of the amounts recoverable from reinsurance and specialpurpose vehicles.TP.2.9. Cash-flow projections should reflect expected realistic futuredemographic, legal, medical, technological, social or economicdevelopments.TP.2.10. Appropriate assumptions for future inflation should be built intothe cash-flow projection.Care should be taken to identify the type of inflation to which particularcash-flows are exposed (i.e. consumer price index, salary inflation).TP.2.11. The cash-flow projections, in particular for health insurancebusiness, should take account of claims inflation and any premiumadjustment clauses.It may be assumed that the effects of claims inflation and premiumadjustment clauses cancel each other out in the cash flow projection,provided this approach undervalues neither the best estimate, nor therisk involved with the higher cash flows after claims inflation andpremium adjustment. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 31. Recognition and derecognition of (re)insurance contracts forsolvency purposesTP.2.12. The calculation of the best estimate should only include futurecash-flows associated with obligations within the boundary of thecontract.TP.2.13. A reinsurance or insurance obligation should be initiallyrecognised by insurance or reinsurance undertakings at whichever is theearlier of the date the undertaking becomes a party to the contract thatgives rise to the obligation or the date the insurance or reinsurance coverbegins.TP.2.14. A contract should be derecognised as an existing contract onlywhen the obligation specified in the contract is extinguished, dischargedor cancelled or expires.The boundary of an existing (re)insurance contractTP.2.15. The definition of the contract boundary should be applied inparticular to decide whether options to renew the contract, to extend theinsurance coverage to another person, to extend the insurance period, toincrease the insurance cover or to establish additional insurance covergives rise to a new contract or belongs to the existing contract.Where the option belongs to the existing contract the provisions forpolicyholder options should be taken into account.TP.2.16. For the purpose of determining which insurance or reinsuranceobligations arise in relation to an insurance or reinsurance contract, theboundaries of the contract shall be defined in the following manner:(a) Where the insurance or reinsurance undertaking has at a future date:(i) A unilateral right to terminate the contract,(ii) A unilateral right to reject premiums payable under the contract, or(iii) A unilateral right to amend the premiums or the benefits payableunder the contract in such a way that the premiums fully reflect the risks, _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 32. any obligations which relate to insurance or reinsurance cover whichmight be provided by the undertaking after that date do not belong tothe contract, unless the undertaking can compel the policy holder to paythe premium for those obligations;(b) Where the insurance or reinsurance undertaking has a unilateral rightas referred to in point (a) that relates only to a part of the contract, thesame principle as defined in point (a) shall be applied to this part;(c) Notwithstanding points (a) and (b), where an insurance orreinsurance contract:(i) Does not provide compensation for a specified uncertain event thatadversely affects the insured person,(ii) Does not include a financial guarantee of benefits, any obligationsthat do not relate to premiums which have already been paid do notbelong to the contract, unless the undertaking can compel the policyholder to pay the future premium;(d) Notwithstanding points (a) and (b), where an insurance orreinsurance contract can be unbundled into two parts and where one ofthese parts meets the requirements set out in points (c)(i) and (ii), anyobligations that do not relate to the premiums of that part and whichhave already been paid do not belong to the contract, unless theundertaking can compel the policy holder to pay future premium of thatpart;(e) All other obligations relating to the contract, including obligationsrelating to unilateral rights of the insurance or reinsurance undertakingto renew or extend the scope of the contract and obligations that relate topaid premiums, belong to the contract.TP.2.17. Where an insurance or reinsurance undertaking has theunilateral right to amend the premiums or benefits of a portfolio ofinsurance or reinsurance obligations in such a way that the premiums ofthe portfolio fully reflect the risks covered by the portfolio, theundertakings unilateral right to amend the premiums or benefits ofthose obligations shall be regarded as complying with the condition setout in paragraph TP.2.16(a). _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 33. TP.2.18. Premiums shall be regarded as fully reflecting the risks coveredby a portfolio of insurance or reinsurance obligations, only where there isno scenario under which the amount of the benefits and expensespayable under the portfolio exceeds the amount of the premiums payableunder the portfolio;TP.2.19. Notwithstanding paragraph TP.2.17, in the case of lifeinsurance obligations where an individual risk assessment of theobligations relating to the insured person of the contract is carried out atthe inception of the contract and that assessment cannot be repeatedbefore amending the premiums or benefits, the assessment of whetherthe premiums fully reflect the risk in accordance with the condition setout in paragraph 1(a) shall be made at the level of the contract.TP.2.20. For the purpose of points (a) and (b) of paragraph TP.2.16,restrictions of the unilateral right and limitations of the extent by whichpremiums and benefits can be amended that have no discernible effecton the economics of the contract, shall be ignored.TP.2.21. For the purpose of points (c) and (d) of paragraph TP.2.16,coverage of events and guarantees that have no discernible effect on theeconomics of the contract, shall be ignored.TP.2.22. Annex D includes several examples that illustrate theapplication of the definition of the contract boundary.Time horizonTP.2.23. The projection horizon used in the calculation of best estimateshould cover the full lifetime of all the cash in- and out-flows required tosettle the obligations related to existing insurance and reinsurancecontracts on the date of the valuation, unless an accurate valuation canbe achieved otherwise.TP.2.24. The determination of the lifetime of insurance and reinsuranceobligations should be based on up-to-date and credible information andrealistic assumptions about when the existing insurance and reinsuranceobligations will be discharged or cancelled or expired. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 34. Gross cash in-flowsTP.2.25. To determine the best estimate the following non-exhaustivelist of cash in-flows should be included:- Future premiums; and- Receivables for salvage and subrogation.TP.2.26. The cash in-flows should not take into account investmentreturns (i.e. interests earned, dividends…).Gross cash out-flowsTP.2.27. The cash out-flows could be divided between benefits to thepolicyholders or beneficiaries, expenses that will be incurred in servicinginsurance and reinsurance obligations, and other cash-flow items suchas taxation payments which are charged to policyholders.BenefitsTP.2.28. The benefit cash out-flows (non-exhaustive list) should include:- Claims payments- Maturity benefits- Death benefits- Disability benefits- Surrender benefits- Annuity payments- Profit sharing bonusesExpensesTP.2.29. In determining the best estimate, the undertaking should takeinto account all cash-flows arising from expenses that will be incurred inservicing all recognised insurance and reinsurance obligations over thelifetime thereof. This should include (non-exhaustive list): _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 35. - Administrative expenses- Investment management expenses- Claims management expenses / handling expensesTP.2.30. Expenses that are pertinent to the valuation of technicalprovisions would usually include both allocated and overhead expenses.Allocated expenses are those expenses which could be directlyassignable to the source of expense that will be incurred in servicinginsurance and reinsurance obligations.Overhead expenses comprise all other expenses which the undertakingincurs in servicing insurance and reinsurance obligations.TP.2.31. Overhead expenses include, for example, expenses which arerelated to general management and service departments which are notdirectly involved in new business or policy maintenance activities andwhich are insensitive to either the volume of new business or the level ofin-force business.The allocation of overhead expenses to homogeneous risk groups or thepremium provisions and the provisions for claims outstanding shall bedone in a realistic and objective manner and on a consistent basis overtime.The same requirements shall apply to the allocation of overheadexpenses to existing and future business.TP.2.32. Administrative expenses are expenses which are connected withpolicy administration including expenses in respect of reinsurancecontracts and special purpose vehicles.Some administrative expenses relate directly to insurance contract orcontract activity (e.g. maintenance cost) such as cost of premium billing,cost of sending regular information to policyholders and cost of handlingpolicy changes (e.g. conversions and reinstatements). _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 36. Other administrative expenses relate directly to insurance contracts orcontract activity but are a result of activities that cover more than onepolicy such as salaries of staff responsible for policy administration.TP.2.33. Investment management expenses are usually not allocated ona policy by policy basis but at the level of a portfolio of insurancecontracts.Investment management expenses could include expenses ofrecordkeeping of the investments’ portfolio, salaries of staff responsiblefor investment, remunerations of external advisers, expenses connectedwith investment trading activity (i.e. buying and selling of the portfoliosecurities) and in some cases also remuneration for custodial services.Investment management expenses have to be based on a portfolio ofassets appropriate to cover their portfolio of obligations.In case the future discretionary benefits depend on the assets held by theundertaking and for unit-linked contracts the undertaking should ensurethat the future investment management expenses allow for the expectedchanges to the future aforementioned portfolio of assets.In particular, a dynamic expense allowance should be used to reflect adynamic asset strategy.TP.2.34. Usually investment management expenses differ regardingdifferent assets classes.To ensure that investment management expenses will properly reflectthe characteristics of the portfolio, investment management expenses inrelation to different assets will be based on existing and predicted futuresplit of assets.TP.2.35. Investment management expenses are considered as cash out-flow in the calculation of the best estimate since discounting is madewith a yield curve gross of investment expenses. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 37. TP.2.36. Claims management expenses are expenses that will beincurred in processing and resolving claims, including legal andadjuster’s fees and internal costs of processing claims payments. Some ofthese expenses could be assignable to individual claim (e.g. legal andadjuster’s fees), others are a result of activities that cover more than oneclaim (e.g. salaries of staff of claims handling department).TP.2.37. Acquisition expenses include expenses which can be identifiedat the level of individual insurance contract and have been incurredbecause the undertaking has issued that particular contract.These are commission costs, costs of selling, underwriting and initiatingan insurance contract that has been issued.TP.2.38. Overhead expenses include salaries to general managers,auditing costs and regular day-to-day costs i.e. electricity bill, rent foraccommodations, IT costs.These overhead expenses also include expenses related to thedevelopment of new insurance and reinsurance business, advertisinginsurance products, improvement of the internal processes such asinvestment in system required to support insurance and reinsurancebusiness (e.g. buying new IT system and developing new software).TP.2.39. Expenses connected with activities which are not linked withservicing insurance and reinsurance obligations are not taken intoaccount when calculating technical provisions.Such expenses could be for example company pension scheme deficits,holding companies’ operational expenses connected with expenseslinked to entities which are not insurance or reinsurance undertakings.TP.2.40. Undertakings should value and take into account charges forembedded options in the valuation of the technical provisions wherepossible. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 38. For life insurance contracts with embedded options it is rather commonthat for the cost of the embedded option only a minor charge is made upfront and that the remainder is due in an extended period of time.This does not necessarily have to be the total time until maturity and isin general not necessary fixed or known exactly in advance.Charges from embedded options are taken into account in the bestestimate valuation of technical provisions and they are kept separatelyfrom expense loadings.For example a surrender charge could possibly be seen as a charge tooffset the uncollected charges in average, but could also be seen as a wayto force the policyholder to continue the contract and hence it would notdirectly be related to the cost of embedded options.TP.2.41. To the extent that future premiums from existing insurance andreinsurance contracts are taken into account in the valuation of the bestestimate, expenses relating to these future premiums should be takeninto consideration.TP.2.42. Undertaking should consider their own analysis of expensesand any relevant data from external sources such as average industry ormarket data.Undertakings should assess the availability of market data on expensesby considering the representativeness of the market data relative to theportfolio and the credibility and reliability of the data.TP.2.43. Where average market information is used, consideration needsto be given as to the representativeness of the data used to form thataverage.For example, market information is not deemed to be sufficientlyrepresentative where the market information has material dispersion inrepresentativeness of the portfolios whose data have been used tocalculate such market information. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 39. The assessment of credibility considers the volume of data underlyingthe market information.TP.2.44. Assumptions with respect to future expenses arising fromcommitments made on or prior to the date of valuation have to beappropriate and take into account the type of expenses involved.Undertakings should ensure that expense assumptions allow for futurechanges in expenses and such an allowance for inflation is consistentwith the economic assumptions made.Future expense cash flows are usually assumed to vary with assumedrates of general level of expense inflation in a reasonable manner.TP.2.45. Relevant market data needs to be used to determine expenseassumptions which include an allowance for future cost increase.The correlation between inflation rates and interest rates are taken intoaccount.An undertaking needs to ensure that the allowance for inflation isconsistent with the economic assumptions made, which could beachieved if the probabilities for each inflation scenario are consistentwith probabilities implied by market interest rates.Furthermore, expense inflation must be consistent with the types ofexpenses being considered (e.g. different levels of inflation would beexpected regarding office space rents, salaries of different types of staff,IT systems, medical expenses, etc.).TP.2.46. Any assumptions about the expected cost reduction should berealistic, objective and based on verifiable data and information.TP.2.47. For the assessment of the future expenses, undertakings shouldtake into account all the expenses that are directly related to the on-going administration of obligations related to existing insurance and _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 40. reinsurance contracts, together with a share of the relevant overheadexpenses.The share of overheads should be assessed on the basis that theundertaking continues to write further new business.Overhead expenses have to be apportioned between existing and futurebusiness based on recent analyses of the operations of the business andthe identification of appropriate expense drivers and relevant expenseapportionment ratios.Cash flow projections should include, as cash out-flows, the recurrentoverheads attributable to the existing business at the calculation date ofthe best estimate.TP.2.48. In order to determine which expenses best reflect thecharacteristics of the underlying portfolio and to ensure that thetechnical provisions are calculated in a prudent, reliable and objectivemanner, insurance and reinsurance undertakings should consider theappropriateness of both market consistent expenses and undertakingspecific expenses.If sufficiently reliable, market consistent expenses are not availableparticipants should use undertaking-specific information to determineexpenses that will be incurred in servicing insurance and reinsuranceobligations provided that the undertaking-specific information isassessed to be appropriate.TP.2.49. Expenses, that are determined by contracts between theundertaking and third parties have to be taken into account based on theterms of the contract.In particular, commissions arising from insurance contracts have to beconsidered based on the terms of the contracts between theundertakings and the sales persons, and expenses in respect ofreinsurance are taken into account based on the contracts between theundertaking and its reinsurers. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 41. Tax paymentsTP.2.50. In determining the best estimate, undertakings should take intoaccount taxation payments which are charged to policyholders.Only those taxation payments which are settled by the undertaking needto be taken into account.A gross calculation of the amounts due to policyholders suffices wheretax payments are settled by the policyholders;TP.2.51. Different taxation regimes exist across Member States givingrise to a broad variety of tax rules in relation to insurance contracts.The assessment of the expected cash-flows underlying the technicalprovisions should take into account any taxation payments which arecharged to policyholders, or which would be required to be made by theundertaking to settle the insurance obligations.All other tax payments should be taken into account under other balancesheet items.TP.2.52. The following tax payments should be included in the bestestimate: transaction-based taxes (such as premium taxes, value addedtaxes and goods and services taxes) and levies (such as fire service leviesand guarantee fund assessments) that arise directly from existinginsurance contracts, or that can be attributed to the contracts on areasonable and consistent basis.Contributions which were already included in companies’ expenseassumptions (i.e. levies paid by insurance companies to industryprotection schemes) should not be included.TP.2.53. The allowance for tax payments in the best estimate should beconsistent with the amount and timing of the taxable profits and lossesthat are expected to be incurred in the future.In cases where changes to taxation requirements are substantiallyenacted, the pending adjustments should be reflected. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 42. TP.2.54. Homogeneous risk groups of life insurance obligationsThe cash-flow projections used in the calculation of best estimates forlife insurance obligations shall be made separately for each policy.Where the separate calculation for each policy would be an undueburden on the insurance or reinsurance undertaking, it may carry out theprojection by grouping policies, provided that the grouping complieswith the following requirements:(1) There are no significant differences in the nature and complexity ofthe risks underlying the policies that belong to the same group;(2) The grouping of policies does not misrepresent the risk underlyingthe policies and does not misstate their expenses;(3) The grouping of policies is likely to give approximately the sameresults for the best estimate calculation as a calculation on a per policybasis, in particular in relation to financial guarantees and contractualoptions included in the policies.TP.2.55. In certain specific circumstances, the best estimate element oftechnical provisions may be negative (e.g. for some individual contracts).This is acceptable and undertakings should not set to zero the value ofthe best estimate with respect to those individual contracts.TP.2.56. No implicit or explicit surrender value floor should be assumedfor the amount of the market consistent value of liabilities for a contract.This means that if the sum of a best estimate and a risk margin of acontract is lower than the surrender value of that contract there is noneed to increase the value of insurance liabilities to the surrender valueof the contract. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 43. Non-life insurance obligationsTP.2.57. The valuation of the best estimate for provisions for claimsoutstanding and for premium provisions should be carried outseparately.With respect to the best estimate for premium provisions, the cash-flowprojections relate to claim events occurring after the valuation date andduring the remaining in-force period (coverage period) of the policiesheld by the undertaking (existing policies).The cash-flow projections should comprise all future claim paymentsand claims administration expenses arising from these events, cash-flows arising from the ongoing administration of the in-force policiesand expected future premiums stemming from existing policies.TP.2.58. The best estimate of premium provisions from existinginsurance and reinsurance contracts should be given as the expectedpresent value of future in- and out-going cash-flows, being acombination of, inter alia:- cash-flows from future premiums;- cash-flows resulting from future claims events;- cash-flows arising from allocated and unallocated claims administration expenses;- cash-flows arising from ongoing administration of the in-force policies.There is no need for the listed items to be calculated separately.TP.2.59. With regard to premium provisions, the cash in-flows couldexceed the cash out-flows leading to a negative best estimate. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 44. This is acceptable and undertakings are not required to set to zero thevalue of the best estimate.The valuation should take account of the time value of money whererisks in the remaining period would give rise to claims settlements intothe future.TP.2.60. Additionally, the valuation of premium provisions should takeaccount of future policyholder behaviour such as likelihood of policylapse during the remaining period.TP.2.61. With respect to the best estimate for provisions for claimsoutstanding, the cash-flow projections relate to claim events havingoccurred before or at the valuation date – whether the claims arisingfrom these events have been reported or not (i.e. all incurred but notsettled claims).The cash-flow projections should comprise all future claim payments aswell as claims administration expenses arising from these events.TP.2.62. Where non-life insurance policies give rise to the payment ofannuities, the approach laid down in the following subsection onsubstance over form should be followed.Consistent with this, for premium provisions, its assessment shouldinclude an appropriate calculation of annuity obligations if a materialamount of incurred claims is expected to give rise to the payment ofannuities.Principle of substance over formTP.2.63. When discussing valuation techniques for calculating technicalprovisions, it is common to refer to a distinction between a valuationbased on life techniques and a valuation based on non-life techniques. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 45. The distinctions between life and non-life techniques are aimed towardsthe nature of the liabilities (substance), which may not necessarily matchthe legal form (form) of the contract that originated the liability.The choice between life or non-life actuarial methodologies should bebased on the nature of the liabilities being valued and from theidentification of risks which materially affect the underlying cash-flows.This is the essence of the principle of substance over form.TP.2.64. Traditional life actuarial techniques to calculate the bestestimate can be described as techniques that are based on discountedcash-flow models, generally applied on a policy-by-policy basis, whichtake into account in an explicit manner risk factors such as mortality,survival and changes in the health status of the insured person(s).TP.2.65. On the other hand, traditional non-life actuarial techniquesinclude a number of different approaches.For example some of the most common being:- Methodologies based on the projection of run-off triangles, usually constructed on an aggregate basis;- Frequency/severity models, where the number of claims and the severity of each claim is assessed separately;- Methodologies based on the estimation of the expected loss ratio or other relevant ratios;- Combinations of the previous methodologies;TP.2.66. There is one key difference between life and non-life actuarialmethodologies: life actuarial methodologies consider explicitly theprobabilities of death, survival, disability and/or morbidity of theinsured persons as key parameters in the model, while non-life actuarialmethodologies do not. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 46. TP.2.67. The choice between life or non-life actuarial methodologiesshould be based on the nature of the liabilities valued and on theidentification of risks which materially affect the underlying cash-flows.TP.2.68. In practice, in the majority of cases the form will correspond tothe substance.However, for example for certain supplementary covers included in lifecontracts (e.g. accident) may be better suited for an estimation based onnon-life actuarial methodologies.TP.2.69. The following provides additional guidance for the treatment ofannuities arising in non-life insurance.The application of the principle of substance over form implies that suchliabilities should be valued using methodologies usually applicable tothe valuation of life technical provisions,Specifically, guidance is provided in relation to:- the recognition and segmentation of insurance obligations for the purpose of calculating technical provisions (i.e. the allocation of obligations to the individual lines of business);- the valuation of technical provisions for such annuities; and- possible methods for the valuation of technical provisions for the remaining non-life obligationsTP.2.70. The treatment proposed in these specifications for annuitiesshould be extended to other types of liabilities stemming from non-lifeand health insurance whose nature is deemed similar to life liabilities(such as life assistance benefits), taking into consideration the principlementioned in the previous paragraph. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 47. Allocation to the individual lines of businessTP.2.71. Where non-life and Non-SLT health insurance policies give riseto the payment of annuities such liabilities should be valued usingtechniques commonly used to value life insurance obligations. Suchliabilities should be assigned to the lines of business for annuitiesstemming from non-life contracts.Valuation of annuities arising from non-life and Non-SLThealth insurance contractsTP.2.72. Undertakings should value the technical provisions related tosuch annuities separately from the technical provisions related to theremaining non-life and health obligations.They should apply appropriate life insurance valuation techniques.The valuation should be consistent with the valuation of life insuranceannuities with comparable technical features.Valuation of the remaining non-life and health insuranceobligationsTP.2.73. The remaining obligations in the undertaking’s non-life andNon-SLT health business (which are similar in nature to non-lifeinsurance obligations) have to be valued separately from the relevantblock of annuities.TP.2.74. Where provisions for claims outstanding according to nationalaccounting rules are compared to provisions for claims outstanding ascalculated above, it should be taken into account that the latter do notinclude the annuity obligations.TP.2.75. Undertakings may use, where appropriate, one of the followingapproaches to determine the best estimate of claims provisions for theremaining non-life or health obligations in a given non-life or Non-SLThealth insurance line of business where annuities are valued separately. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 48. Separate calculation of non-life liabilitiesTP.2.76. Under this approach, the run-off triangle which is used as abasis for the determination of the technical provisions should not includeany cash-flows relating to the annuities.An additional estimate of the amount of annuities not yet reported andfor reported but not yet agreed annuities needs to be added.Allowance of agreed annuities as single lump-sum payments inthe run-off triangleTP.2.77. This approach also foresees a separate calculation of the bestestimate, where the split is between annuities in payment and theremaining obligations.TP.2.78. Under this approach, the run-off triangle which is used as abasis for the determination of the technical provisions of the remainingnon-life or health obligations in a line of business does not include anycash-flows relating to the annuities in payment.This means that claims payments for annuities in payment are excludedfrom the run-off triangle.TP.2.79. However, payments on claims before annuitisation1 andpayments at the time of annuitisation remain included in the run-offtriangle.At the time of annuitisation, the best estimate of the annuity (valuedseparately according to life principles) is shown as a single lump-sumpayment in the run-off triangle, calculated as at the date of theannuitisation.Where proportionate, approximations of the lump sums could be used. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 49. TP.2.80. Where the analysis is based on run-off triangles of incurredclaims, the lump sum payment should reduce the case reserves at thedate of annuitisation.TP.2.81. On basis of run-off triangles adjusted as described above, theparticipant may apply an appropriate actuarial reserving method toderive a best estimate of the claims provision of the portfolio.Due to the construction of the run-off triangle, this best estimate wouldnot include the best estimate related to the annuities in payment whichwould be valued separately using life principles (i.e. there would be no“double counting” in relation to the separate life insurance valuation),but it includes a best estimate for not yet reported and for reported butnot yet agreed annuities.Expert judgementTP.2.82. Insurance and reinsurance undertakings shall chooseassumptions based on the expertise of persons with relevant knowledge,experience and understanding of the risks inherent in the insurance orreinsurance business thereof (expert judgment).In certain circumstances expert judgement may be necessary whencalculating the best estimate, among other:- in selecting the data to use, correcting its errors and deciding the treatment of outliers or extreme events,- in adjusting the data to reflect current or future conditions, and adjusting external data to reflect the undertaking’s features or the characteristics of the relevant portfolio,- in selecting the time period of the data- in selecting realistic assumptions _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 50. - in selecting the valuation technique or choosing the most appropriate alternatives existing in each methodology- in incorporating appropriately to the calculations the environment under which the undertakings have to run its business.TP.2.83. In the case of non-life insurance and non-life reinsuranceobligations, participants should allocate the expenses into homogenousrisk groups, as a minimum by line of business according to thesegmentation of their obligations used in the calculation of technicalprovisions.Undertakings should allocate the expenses of non-life insurance andreinsurance obligations to premium provisions and to provisions forclaims outstanding.Obligations in different currenciesTP.2.84. The probability-weighted average cash-flows should take intoaccount the time value of money.The time value of money of future cash-flows in different currencies iscalculated using risk-free term structure for relevant currency.Therefore the best estimate should be calculated separately forobligations of different currencies.Valuation of options and guarantees embedded in insurancecontractsTP.2.85. When calculating the best estimate, insurance and reinsuranceundertakings shall identify and take into account:1. All financial guarantees and contractual options included in theirinsurance and reinsurance policies; _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 51. 2. All factors which may materially affect the likelihood that policyholders will exercise contractual options or the value of the option orguarantee.Definition of contractual options and financial guaranteesTP.2.86. A contractual option is defined as a right to change thebenefits2, to be taken at the choice of its holder (generally thepolicyholder), on terms that are established in advance.Thus, in order to trigger an option, a deliberate decision of its holder isnecessary.TP.2.87. Some (non-exhaustive) examples of contractual options whichare pre-determined in contract and do not require again the consent ofthe parties to renew or modify the contract include the following:- Surrender value option, where the policyholder has the right to fully or partially surrender the policy and receive a pre-defined lump sum amount;- Paid-up policy option, where the policyholder has the right to stop paying premiums and change the policy to a paid-up status;- Annuity conversion option, where the policyholder has the right to convert a lump survival benefit into an annuity at a pre-defined minimum rate of conversion;- Policy conversion option, where the policyholder has the right to convert from one policy to another at pre-specific terms and conditions;- Extended coverage option, where the policyholder has the right to extend the coverage period at the expiry of the original contract without producing further evidence of health. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 52. TP.2.88. A financial guarantee is present when there is the possibility topass losses to the undertaking or to receive additional benefits as a resultof the evolution of financial variables (solely or in conjunction with non-financial variables) (e.g. investment return of the underlying assetportfolio, performance of indices, etc.).In the case of guarantees, the trigger is generally automatic (themechanism would be set in the policy’s terms and conditions) and thusnot dependent on a deliberate decision of the policyholder / beneficiary.In financial terms, a guarantee is linked to option valuation.TP.2.89. The following is a non-exhaustive list of examples of commonfinancial guarantees embedded in life insurance contracts:- Guaranteed invested capital- Guaranteed minimum investment return- Profit sharingTP.2.90. There are also non-financial guarantees, where the benefitsprovided would be driven by the evolution of non-financial variables,such as reinstatement premiums in reinsurance, experience adjustmentsto future premiums following a favourable underwriting history (e.g.guaranteed no-claims discount).Where these guarantees are material, the calculation of technicalprovisions should also take into account their value.Valuation requirementsTP.2.91. For each type of contractual option insurers are required toidentify the risk drivers which have the potential to materially affect(directly or indirectly) the frequency of option take-up rates consideringa sufficiently large range of scenarios, including adverse ones. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 53. TP.2.92. The best estimate of contractual options and financialguarantees must capture the uncertainty of cash-flows, taking intoaccount the likelihood and severity of outcomes from multiple scenarioscombining the relevant risk drivers.TP.2.93. The best estimate of contractual options and financialguarantees should reflect both the intrinsic value and the time value.TP.2.94. The best estimate of contractual options and financialguarantees may be valued by using one or more of the followingmethodologies:- A stochastic approach using for instance a market-consistent asset model (includes both closed form and stochastic simulation approaches);- A series of deterministic projections with attributed probabilities; and- A deterministic valuation based on expected cash-flows in cases where this delivers a market-consistent valuation of the technical provision, including the cost of options and guarantees.TP.2.95. For the purposes of valuing the best estimate of contractualoptions and financial guarantees, a stochastic simulation approachwould consist of an appropriate market-consistent asset model forprojections of asset prices and returns (such as equity prices, fixedinterest rate and property returns), together with a dynamic modelincorporating the corresponding value of liabilities (incorporating thestochastic nature of any relevant non-financial risk drivers) and theimpact of any foreseeable actions to be taken by management.TP.2.96. For the purposes of the deterministic approach, a range ofscenarios or outcomes appropriate to both valuing the options orguarantees and the underlying asset mix, together with the associatedprobability of occurrence should be set. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 54. These probabilities of occurrence should be weighted towards adversescenarios to reflect market pricing for risk.The series of deterministic projections should be numerous enough tocapture a wide range of possible out-comes (and, in particular, it shouldinclude very adverse yet possible scenarios) and take into account theprobability of each outcomes likelihood (which may, in practice, need toincorporate judgement).The costs will be understated if only relatively benign or limitedeconomic scenarios are considered.TP.2.97. When the valuation of the best estimate of contractual optionsand financial guarantees is not being done on a policy-by-policy basis,the segmentation considered should not distort the valuation of technicalprovisions by, for example, forming groups containing policies which are"in the money" and policies which are "out of the money".TP.2.98. Regarding contractual options, the assumptions onpolicyholder behaviour should be appropriately founded in statisticaland empirical evidence, to the extent that it is deemed representative ofthe future expected behaviour.However, when assessing the experience of policyholders’ behaviourappropriate attention based on expert judgements should be given to thefact that when an option is out of or barely in the money, the behaviourof policyholders should not be considered to be a reliable indication oflikely policyholders’ behaviour when the options are heavily in-the-money.TP.2.99. Appropriate consideration should also be given to an increasingfuture awareness of policy options as well as policyholders’ possiblereactions to a changed financial position of an undertaking.In general, policyholders’ behaviour should not be assumed to beindependent of financial markets, a firm’s treatment of customers or _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 55. publicly available information unless proper evidence to support theassumption can be observed.TP.2.100. Where material, non-financial guarantees should be treatedlike financial guarantees.Valuation of future discretionary benefitsTP.2.101. In calculating the best estimate, undertakings should take intoaccount future discretionary benefits which are expected to be made,whether or not those payments are contractually guaranteed.Undertakings should not take into account payments that relate tosurplus funds which possess the characteristics of Tier 1 basic ownfunds. Surplus funds are accumulated profits which have not been madeavailable for distribution to policyholders and beneficiaries. (Cf. Article91 of the Solvency II Framework Directive.)TP.2.102. When undertakings calculate the best estimate of technicalprovisions, the value of future discretionary benefits should be calculatedseparately.TP.2.103. Future discretionary benefits means benefits of insurance orreinsurance contracts which have one of the following characteristics:- The benefits are legally or contractually based on one or several of the following results:- The performance of a specified pool of contracts or a specified type of contract or a single contract;- Realised or unrealised investment return on a specified pool of assets held by the insurance or reinsurance undertaking;- The profit or loss of the insurance or reinsurance undertaking or fund that issues the contract that gives rise to the benefits; _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 56. - The benefits are based on a declaration of the insurance or reinsurance undertaking and the timing or the amount of the benefits is at its discretion.TP.2.104. Index-linked and unit-linked benefits should not be consideredas discretionary benefits.TP.2.105. The distribution of future discretionary benefits is amanagement action and assumptions about it should be objective,realistic and verifiable.In particular assumptions about the distribution of future discretionarybenefits should take the relevant and material characteristics of themechanism for their distribution into account.TP.2.106. Some examples of characteristics of mechanisms fordistributing discretionary benefits are the following.Undertakings should consider whether they are relevant and material forthe valuation of future discretionary benefits and take them into accountaccordingly, applying the principle of proportionality.- What constitutes a homogenous group of policyholders and what are the key drivers for the grouping?- How is a profit divided between owners of the undertaking and the policyholders and furthermore between different policyholders?- How is a deficit divided between owners of the undertaking and the policyholders and furthermore between different policyholders?- How will the mechanism for discretionary benefits be affected by a large profit or loss?- How will policyholders be affected by profits and losses from other activities? _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 57. - What is the target return level set by the firm’s owners on their invested capital?- What are the key drivers affecting the level of discretionary benefits?- What is an expected level (inclusive of any distribution of excess capital, unrealised gains etc.) of discretionary benefits?- How are the discretionary benefits made available for policyholders and what are the key drivers affecting for example the split between reversionary and terminal discretionary benefits, conditionality, changes in smoothing practice, level of discretionary by the undertaking, etc.- How will the experience from current and previous years affect the level of discretionary benefits?- When is an undertakings solvency position so weak that declaring discretionary benefits is considered by the undertaking to jeopardize a shareholder’s or/and policyholders’ interest?- What other restrictions are in place for determining the level of discretionary benefits?- What is an undertakings investment strategy?- What is the asset mix driving the investment return?- What is the smoothing mechanism if used and what is the interplay with a large profit or loss?- What kind of restrictions are in place in smoothing extra benefits?- Under what circumstances would one expect significant changes in the crediting mechanism for discretionary benefits?- To what extent is the crediting mechanism for discretionary benefits sensitive to policyholders’ actions? _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 58. TP.2.107. Where the future discretionary benefits depend on the assetsheld by the undertaking, the calculation of the best estimate should bebased on the current assets held by the undertaking.Future changes of the asset allocation should be taken into accountaccording to the requirements on future management actions.TP.2.108. The assumptions on the future returns of these assets, valuedaccording to the subsection V.1, should be consistent with the relevantrisk-free interest term structure for the Quantitative Assessment.Where a risk neutral approach for the valuation is used, the set ofassumptions on returns of future investments underlying the valuation ofdiscretionary benefits should be consistent with the principle that theyshould not exceed the level given by the forward rates derived from therisk-free interest rates.Assumptions underlying the calculation of the best estimateAssumptions consistent with information provided by financialmarketsTP.2.109. Assumptions consistent with information about or provided byfinancial markets include (non-exhaustive list):- relevant risk-free interest rate term structure,- currency exchange rates,- market inflation rates (consumer price index or sector inflation) and- economic scenario files (ESF).TP.2.110. When undertakings derive assumptions on future financialmarket parameters or scenarios, they should be able to demonstrate that _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 59. the choice of the assumptions is appropriate and consistent with thevaluation principles set out in subsection V.1;TP.2.111. Where the undertaking uses a model to produce futureprojections of market parameters (market consistent asset model, e.g. aneconomic scenario file), such model should comply with the followingrequirements:i. It generates asset prices that are consistent with deep, liquid andtransparent financial markets 4;ii. It assumes no arbitrage opportunity;TP.2.112. The following principles should be taken into account indetermining the appropriate calibration of a market consistent assetmodel:a) The asset model should be calibrated to reflect the nature and term ofthe liabilities, in particular of those liabilities giving rise to significantguarantee and option costs.b) The asset model should be calibrated to the current risk-free termstructure used to discount the cash flows.c) The asset model should be calibrated to a properly calibrated volatilitymeasure.TP.2.113. In principle, the calibration process should use market pricesonly from financial markets that are deep, liquid and transparent.If the derivation of a parameter is not possible by means of prices fromdeep, liquid and transparent markets, other market prices may be used.In this case, particular attention should be paid to any distortions of themarket prices. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 60. Corrections for the distortions should be made in a deliberate, objectiveand reliable manner.TP.2.114. A financial market is deep, liquid and transparent, if it meetsthe requirements specified in the subsection of these specificationsregarding circumstances in which technical provisions should becalculated as a whole.TP.2.115. The calibration of the above mentioned assets models may alsobe based on adequate actuarial and statistical analysis of economicvariables provided they produce market consistent results.For example:a) To inform the appropriate correlations between different asset returns.b) To determine probabilities of transitions between rating classes anddefault of corporate bonds.c) To determine property volatilities.As there is virtually no market in property derivatives, it is difficult toderive property implied volatility. Thus the volatility of a property indexmay often be used instead of property implied volatility.Assumptions consistent with generally available data oninsurance and reinsurance technical risksTP.2.116. Generally available data refers to a combination of:- Internal data- External data sources such as industry or market data.TP.2.117. Internal data refers to all data which is available from internalsources. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 61. Internal data may be either:- Undertaking-specific data:- Portfolio-specific data:TP.2.118. All relevant available data whether external or internal data,should be taken into account in order to arrive at the assumption whichbest reflects the characteristics of the underlying insurance portfolio.In the case of using external data, only that which the undertaking canreasonably be expected to have access too should be considered.The extent to which internal data is taken into account should be basedon:- The availability, quality and relevance of external data.- The amount and quality of internal data.TP.2.119. Where insurance and reinsurance undertakings use data froman external source, they should derive assumptions on underwriting risksthat are based on that data according to the following requirements:(a) Undertakings are able to demonstrate that the sole use of data whichare available from an internal source are not more suitable than externaldata; and(b) The origin of the data and assumptions or methodologies used toprocess them is known to the undertaking and the undertaking is able todemonstrate that these assumptions and methodologies appropriatelyreflect the characteristics of the portfolio. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 62. Policyholders’ behaviourTP.2.120. Undertakings are required to identify policyholders’ behaviour.TP.2.121. Any assumptions made by insurance and reinsuranceundertakings with respect to the likelihood that policyholders willexercise contractual options, including lapses and surrenders, should berealistic and based on current and credible information.The assumptions should take account, either explicitly or implicitly, ofthe impact that future changes in financial and non-financial conditionsmay have on the exercise of those options.TP.2.122. Assumptions about the likelihood that policy holders willexercise contractual options should be based on analysis of pastpolicyholder behaviour.The analysis should take into account the following:(a) How beneficial the exercise of the options was or would have been tothe policyholders under past circumstances (whether the option is out ofor barely in the money or is in the money),(b) The influence of past economic conditions,(c) The impact of past management actions,(d) Where relevant, how past projections compared to the actualoutcome,(e) Any other circumstances that are likely to influence a decisionwhether to exercise the option.TP.2.123. The likelihood that policyholders will exercise contractualoptions, including lapses and surrenders, should not be assumed to beindependent of the elements mentioned in points (a) to (e) in the _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 63. previous paragraph, unless proper evidence to support such anassumption can be observed or where the impact would not be material.TP.2.124. In general policyholders’ behaviour should not be assumed tobe independent of financial markets, of undertaking’s treatment ofcustomers or publicly available information unless proper evidence tosupport the assumption can be observed.TP.2.125. Policyholder options to surrender are often dependent onfinancial markets and undertaking-specific information, in particular thefinancial position of the undertaking.TP.2.126. Policyholders’ option to lapse and also in certain cases tosurrender are mainly dependent on the change of policyholders’ statussuch as the ability to further pay the premium, employment, divorce, etc.Management actionsTP.2.127. The methods and techniques for the estimation of future cash-flows, and hence the assessment of the provisions for insuranceliabilities, should take account of potential future actions by themanagement of the undertaking.TP.2.128. As examples, the following should be considered:- changes in asset allocation, as management of gains/losses fordifferent asset classes in order to gain the target segregated fund return;management of cash balance and equity backing ratio with the aim ofmaintaining a defined target asset mix in the projection period;management of liquidity according to the asset mix and durationstrategy; actions to maintain a stable allocation of the portfolio assets interm of duration and product type, actions for the dynamic rebalancingof the assets portfolio according to movements in liabilities and changesin market conditions; _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 64. - changes in bonus rates or product changes, for example on policieswith profit participation to mitigate market risks;- changes in expense charge, for example related to guarantee charge, orrelated to an increased charging on unit-linked or index-linked business;TP.2.129. The assumptions on future management actions used in thecalculation of the technical provisions should be determined in anobjective manner.TP.2.130. Assumed future management actions should be realistic andconsistent with the insurance or reinsurance undertaking’s currentbusiness practice and business strategy unless there is sufficient currentevidence that the undertaking will change its practices.TP.2.131. Assumed future management actions should be consistent witheach other.TP.2.132. Insurance and reinsurance undertakings should not assumethat future management actions would be taken that would be contraryto their obligations towards policyholders and beneficiaries or to legalprovisions applicable to the insurance and reinsurance undertakings.The assumed future management actions should take account of anypublic indications by the insurance or reinsurance undertaking as to theactions that it would expect to take, or not take in the circumstancesbeing considered.TP.2.133. Assumptions about future management actions should takeaccount of the time needed to implement the management actions andany expenses caused by them.TP.2.134. Insurance and reinsurance undertakings should be able toverify that assumptions about future management actions are realisticthrough a comparison of assumed future management actions withmanagement actions actually taken previously by the insurance orreinsurance undertaking. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 65. International Association of Insurance SupervisorsIAIS Releases Proposed Policy Measures forGlobal Systemically Important InsurersPublic consultation to continue through 16 December 2012Basel – The International Association of Insurance Supervisors (IAIS)today released its proposed policy measures for global systemicallyimportant insurers, or G-SIIs.The paper was endorsed for consultation by the Financial Stability Board(FSB), which is coordinating the overall project to reduce the moralhazard posed by global systemically important financial institutions.Supervisors, insurers and other interested parties are encouraged tosubmit comments on the proposed policy measures through 16December.“These proposed policy measures are intended to reduce moral hazardand the negative externalities stemming from the potential disorderlyfailure posed by a G-SII,” said Peter Braumüller, Chair of the IAISExecutive Committee.“Each of the proposed policy measures has also been designed to takeaccount of the specific nature of the insurance business model and is theresult of intensive and thorough discussion at the IAIS.”The IAIS has proposed a framework of policy measures for G-SIIs basedupon the general framework published by the FSB with adjustmentsthat, as with the proposed assessment methodology, reflect the factorsthat make insurers different from other financial institutions.The proposal consists of three main types of measures:1. Enhanced Supervision.These measures build on the IAIS Insurance Core Principles and theFSB’s Supervisory Intensity and Effectiveness recommendations and _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 66. include the development of a Systemic Risk Reduction Plan andenhanced liquidity planning and management.2. Effective Resolution.Based on the FSB’s Key Attributes of Effective Resolution Regimes forFinancial Institutions, which include the establishment of CrisisManagement Groups, the elaboration of recovery and resolution plans,the conduct of resolvability assessments, and the adoption of institution-specific cross-border cooperation agreements.The IAIS proposals take account of the specificities of insurance throughthe inclusion of plans for separating non-traditional, non-insurance(NTNI) activities from traditional insurance activities, the potential useof portfolio transfers and run-off arrangements, and the recognition ofexisting policyholder protection and guarantee schemes.3. Higher Loss Absorption (HLA) Capacity.This proposal utilises a cascading approach.In the first step if, and to the extent to which, the G-SII hasdemonstrated effective separation of NTNI activities from traditionalinsurance activities, targeted HLA will be applied to the separateentities.Under the second step, whether or not NTNI activities have beenseparated, an overall assessment of group-wide HLA needed will beundertaken and the group wide supervisor will determine whether theHLA capacity held at the NTNI entities is sufficient or needs to befurther increased.About the IAIS:The IAIS is a global standard setting body whose objectives are topromote effective and globally consistent regulation and supervision ofthe insurance industry in order to develop and maintain fair, safe and _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 67. stable insurance markets for the benefit and protection of policyholders;and to contribute to global financial stability.Its membership includes insurance regulators and supervisors from over190 jurisdictions in some 140 countries.More than 120 organisations and individuals representing professionalassociations, insurance and reinsurance companies, internationalfinancial institutions, consultants and other professionals are Observers.Global Systemically Important Insurers:Proposed Policy MeasuresPublic Consultation DocumentComments due by 16 December 2012Cover noteThe global financial crisis underscored the interconnected nature offinancial firms and the severe financial and economic costs associatedwith public sector interventions for those that were distressed orexpected to fail.It also underscored the need to act promptly and proactively to identifyfirms that are systemically important and to take measures to lessen theimpact and reduce the moral hazard associated with the failure of suchfirms.As such, the International Association of Insurance Supervisors (IAIS) isparticipating in a global initiative, along with other standard setters,central banks and financial sector supervisors, and under the purview ofthe Financial Stability Board (FSB) and G20, to identify globalsystemically important financial institutions (G-SIFIs).The focus of IAIS analysis is in relation to potential global systemicallyimportant insurers (G-SIIs). _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 68. Earlier this year, the IAIS developed an assessment methodology toidentify any insurers whose distress or disorderly failure, because of theirsize, complexity and interconnectedness, would cause significantdisruption to the global financial system and economic activity.The IAIS has now developed a framework of policy measures that shouldbe applied to insurers that are determined to be G-SIIs.Interested parties may wish to consult relevant background paperswhich are available on the IAIS, FSB and Basel Committee on BankingSupervision (Basel Committee) websites, including the IAIS’ reportInsurance and Financial Stability.Other key papers include:• The IMF/FSB/Bank for International Settlements (BIS) staff reportsubmitted to the G20 Finance Ministers and Central Bank Governorsentitled Guidance to Assess the Systemic Importance of FinancialInstitutions, Markets and Instruments (October 2009);• The FSB’s recommendations on Reducing the moral hazard posed bysystemically important financial institutions (SIFIs) (October 2010);• The Basel Committee framework for identifying global systemicallyimportant banks (G-SIBs) and requirements for additional lossabsorbency for G-SIBs (November 2011); and• The determination of the first cohort of G-SIBs (November 2011).All comments will be published on the IAIS website, unless a specificrequest is made for comments to remain confidential.Glossary of abbreviationsBCBS Basel Committee on Banking Supervision (also Basel Committee) _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 69. BIS Bank for International SettlementsCDS Credit Default SwapComFrame IAIS Common Framework for the Supervision ofInternationally Active Insurance GroupsCMGs Crisis Management GroupsFSB Financial Stability BoardG-SIBs Global Systemically Important BanksG-SIFIs Global Systemically Important Financial InstitutionsG-SIIs Global Systemically Important InsurersG20 Group of Twenty CountriesHLA Higher Loss Absorbency or Higher Loss Absorption capacityIAIGs Internationally Active Insurance GroupsIAIS International Association of Insurance SupervisorsICPs IAIS Insurance Core PrinciplesIGT Intra-group TransactionsISDA International Swaps and Derivatives AssociationKey Attributes FSB’s Key Attributes for Effective Resolution RegimesMCR Minimum Capital RequirementNTNI Non-traditional Insurance and Non-insurance activities _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 70. PCR Prescribed Capital RequirementRRPs Recovery and Resolution PlansSIFIs Systemically Important Financial InstitutionsSRRP Systemic Risk Reduction PlanExecutive SummaryFSB framework for G-SIFIsThe Financial Stability Board (FSB) framework for reducing the moralhazard and risk to the global financial system posed by systemicallyimportant financial institutions (SIFIs) recommends several policieswhich should combine to:• Apply more intensive and co-ordinated supervision of SIFIs,• Improve the authorities’ ability to resolve SIFIs in an orderly mannerwithout destabilising the financial system and exposing the taxpayer tothe risk of loss,• Require higher loss absorption (HLA) capacity for SIFIs to reflect thegreater risks that these institutions pose to the global financial system,• Provide other supplementary prudential and other requirements asdetermined by the national authorities.Policy measures proposed by IAISThe IAIS proposes a framework of policy measures for G-SIIs in linewith the FSB recommendations.Measures will often require strong cooperation among authorities,including authorities with responsibility for non-insurance entities. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 71. i) Enhanced supervisionThe foundation for G-SII policy measures is the existing IAIS InsuranceCore Principles (ICPs).The FSB’s “Supervisory Intensity and Effectiveness” recommendations(SIE recommendations) would form the basis of the IAIS’ approach toenhanced supervision.In addition, the IAIS Common Framework for the Supervision ofInternationally Active Insurance Groups (ComFrame) will aim to fosterglobal convergence of regulatory and supervisory measures andapproaches for Internationally Active Insurance Groups (IAIGs),whether or not they are identified as G-SIIs, although ComFrame is notexpected to directly focus on addressing systemic risk.For G-SIIs, the supervisor should have direct powers over holdingcompanies to ensure that a direct approach to consolidated group-widesupervision can be applied.Special attention should be paid to group-wide supervision since G-SIIsare most likely to take the form of a group and NTNI (non-traditionaland non-insurance) activities are often carried out by separate entitieswithin a group and/or the group may have significant interconnectionsto other parts of the financial system.The supervisor should require G-SIIs to have, in particular, adequatearrangements in place to deal with liquidity risk management for thewhole group, primarily for the NTNI business, but secondarily also forthe remainder of the G-SII.The authorities should analyse activities that cause systemic importanceof G-SIIs and take necessary measures to reduce that systemicimportance. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 72. The authorities should oversee the development of a Systemic RiskReduction Plan (SRRP) by each G-SII (in addition to recovery andresolution plans (RRPs)) to reduce that systemic importance andmonitor implementation of the plan.Where feasible and appropriate, the SRRP may include effectiveseparation of systemically important NTNI activities from traditionalinsurance business and/or restrictions or prohibitions of specifiedsystemically important activities or any other measures.Where separation of NTNI activities is contemplated, the SRRP shouldseek to ensure it achieves self-sufficiency in terms of structure andfinancial condition of the separated entities.Structural aspects of self-sufficiency will likely involve a combination ofrestructuring measures and the restriction or prohibition of parentalguarantees and cross-default clauses to ensure that any separation intolegal entities is not undermined by contractual obligations.Self-sufficiency in terms of financial condition means there should be nocapital or funding subsidies or multiple-gearing.The authorities should avoid the creation by the G-SII of non-regulatedentities through the separation of NTNI activities.Any entities used to separate NTNI activities should be effectivelyregulated under direct consolidated group-wide supervision includingcoordination with other involved supervisors, as discussed above.ii) Effective resolutionIn 2011, the FSB published an international standard for resolution –“Key Attributes of Effective Resolution Regimes for FinancialInstitutions” (Key Attributes). _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 73. This standard sets out a range of specific requirements that should applyto any financial institution that could be systemically significant orcritical if it fail.The requirements applied to at least G-SIFIs include(i) The establishment of Crisis Management Groups (CMGs);(ii) The elaboration of recovery and resolution plans (RRPs);(iii) The conduct of resolvability assessments(iv) The adoption of institution-specific cross-border cooperationagreementsFor G-SIIs, effective resolution will take account of the specificities ofinsurance including:• Plans and steps needed for separating NTNI activities from traditionalinsurance activities,• The possible use of portfolio transfers and run off arrangements as partof the resolution of entities conducting traditional insurance activities,and• The existence of policyholder protection and guarantee schemes (orsimilar arrangements) in many jurisdictions.iii) Higher loss absorption (HLA) capacityMandating a higher loss absorption capacity for a G-SII will help toreduce its probability of failure.This is important given the greater risks that the failure of G-SIIs posesto the global financial system. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 74. The IAIS proposes that the following cascading approach to achieveHLA capacity should apply.This is in line with the principle for HLA is to be targeted, wherepossible, at activities that have the potential to generate or aggravatesystemic risk.• Step 1 – if, and to the extent to which, the G-SII has demonstratedeffective separation of NTNI activities from traditional insuranceactivities, targeted HLA will be applied to the separate entitiesconducting NTNI activities.• Step 2 – whether or not NTNI activities have been separated, an overallassessment of group-wide HLA needed is required.In the case where Step 1 has been applied, this should take into accountthe HLA in the separate entities and the fact that separation exists, butonly where that HLA was not created by multiple-gearing through downstreaming capital within the G-SII.The group-wide supervisor determines (in consultation with involvedsupervisors) whether the HLA capacity held at the NTNI entities issufficient or needs to be further increased at the group level.As an alternative to Step 2, there is on-going discussion within the IAISon whether there is a need for group-wide HLA if targeted HLA, andother measures (such as restrictions and prohibitions), are effective inreducing the level of systemic importance to an acceptable level.Instruments comprising the highest quality capital – that is permanentcapital that is fully available to cover losses of the insurer at all times ona going-concern basis – are the appropriate instruments to meet HLAcapacity requirements.The HLA assessment will take into account any capital charges imposedto mitigate the systemic risk of an insurer that are in place undernational legislation. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 75. Regarding the proposed policy measures on HLA, the IAIS willelaborate and develop a concrete plan by the end of 2013.Implementation time frameIt is planned that the first cohort of G-SIIs will be designated andsubsequently published in the first half of 2013.G-SII measures on enhanced supervision (including development of theSRRP) and effective resolution should begin to be implementedimmediately afterwards.The SRRP and measures on effective resolution should be completedwithin 18 months after designation.The implementation of the SRRP should be assessed by the authoritiesin 2016.Measures on HLA capacity should begin to be implemented in 2019 forthe G-SIIs designated in 2017 allowing for the assessment ofimplementation of structural measures in the SRRP.The IAIS expects national authorities to prepare a framework in whichinsurers will be able to provide high quality data for the indicators.To ensure the transparency of the methodology (for the benefit of marketparticipants and to promote market discipline) and the efficientidentification of G-SIIs, the IAIS expects all participating insurers todisclose relevant data when the G-SII policy is implemented and theIAIS will provide reporting guidance.Implementation of G-SII policy measures should be monitored by anIAIS peer review process in order to ensure international consistency.The full implementation timeframe is: _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 76. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 77. 1 Introduction1. The IAIS is participating in a global initiative, along with otherstandard setters, central banks and financial sector supervisors, andunder the purview of the Financial Stability Board (FSB) and G20, toidentify global systemically important financial institutions (G-SIFIs).The focus of IAIS analysis is in relation to potential Global SystemicallyImportant Insurers (G-SIIs).To this end, the IAIS has developed a public consultation document“Global Systemically Important Insurers (G-SIIs): Proposed AssessmentMethodology”, explaining the proposed assessment methodology toidentify any insurers whose distress or disorderly failure, would causesignificant disruption to the global financial system and economicactivity.Any such insurers should be regarded as systemically important on aglobal basis.2. The IAIS has now also developed a proposed framework of policymeasures for G-SIIs.The proposed framework is based upon the general frameworkpublished by the FSB with adjustments.As with the assessment methodology, these adjustments reflect thefactors that make insurers, and the reasons why they might besystemically important, different to other financial institutions.3. At the Summit meeting in Seoul, November 2010, the G20 leadersendorsed the FSB’s framework for reducing the moral hazard posed bysystemically important financial institutions.The framework recommends several policies which should combine to: _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 78. • Improve the authorities’ ability to resolve SIFIs in an orderly mannerwithout destabilising the financial system and exposing the taxpayer tothe risk of loss,• Require higher loss absorbency for SIFIs to reflect the greater risks thatthese institutions pose to the global financial system,• Apply more intensive and co-ordinated supervision of SIFIs,• Strengthen core financial infrastructures, and• Provide other supplementary prudential and other requirements asdetermined by the national authorities.4. As discussed in the IAIS’ report, Insurance and Financial Stability, thetwo most important factors for assessing the systemic importance ofinsurers are non-traditional insurance and non-insurance activities andinterconnectedness.Non-traditional and non-insurance (NTNI) activities are importantbecause, among other matters, the longer timeframe over whichinsurance liabilities can normally be managed may not be present, andinterconnectedness is important because there can be strongconnections between the insurance and banking sectors that can amplifythe impact of stress events.Therefore, the policy measures need to address these causes of systemicimportance.5. The purpose of this consultation document is to seek views fromsupervisors, industry and the public on the proposed policy measuresframework for G-SIIs. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 79. 2 Overview2.1 The supervisory challenges in relation to G-SIIs6. G-SIIs are a risk to financial stability because their scope, the natureof their business and their position in the financial system is such that, ifthey fail, they may cause disruption to the rest of the financial systemand the real economy.7. G-SIIs are different to Global Systemically Important Banks (G-SIBs),in part because the traditional insurance business model is notinherently systemically important.Insurers vary widely from banks in their structures and activities andconsequently in the nature and degree of risks they pose to the globalfinancial system.The activities or variations on the traditional insurance business modelthat would make an insurer a G-SII can vary greatly from one insurer toanother.This requires a policy response designed to address the specific natureand source of systemic importance and the different drivers of possiblenegative externalities.2.2 Objectives of G-SII policy measures8. The proposed G-SII policy measures should reduce moral hazard andthe negative externalities stemming from the potential disorderly failureposed by a G-SII.These policy measures should:• Reduce the probability and impact of distress or failure of G-SIIs andthus reduce the expected systemic impacts which disorderly failure maycause. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 80. • Incentivise G-SIIs to become less systemically important, and givenon-G-SIIs strong disincentives from becoming G-SIIs, and• Be linked to the drivers of the G-SII status of each individual insurer.9. G-SIIs may be regarded as a safe haven by policyholders andinstitutional investors, either because of a perceived implicit stateguarantee or maybe more so because the policy measures are understoodto bring an additional level of security.Within the financial market place, this might have substantialdistortional consequences.For example, the G-SII designation of insurers could result in giving G-SIIs access to lower funding costs.The financial strength rating assessment by credit rating agencies andthe bespoke ratings assigned by investment banks and repo dealerstoday do not assume any implicit state guarantee for insurers.During implementation of the policy measures for G-SIIs, potentialunintended consequences should be considered and avoided wherepossible.3 The G-SII policy measures3.1 Overview10. The IAIS proposes a framework of policy measures for G-SIIs in linewith the FSB recommendations.• Enhanced supervision:Enhanced supervision applies immediately to all G-SIIs to ensure thatthey rapidly achieve the higher standards of risk management their G-SIIstatus demands. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 81. The Insurance Core Principles (ICPs), the common framework forsupervision of internationally active insurance groups (ComFrame), andthe FSB’s “Supervisory Intensity and Effectiveness” (SIE)recommendations would form the basis of the IAIS’s approach toenhanced supervision while special emphasis would be placed on group-wide supervision and liquidity planning, as described below.The authorities should also analyse activities that cause systemicimportance of G-SIIs and take necessary measures to reduce thatsystemic importance.This includes development and implementation of a Systemic RiskReduction Plan (SRRP) which could include measures such asseparation of NTNI activities from traditional insurance businessand/or restriction or prohibition of systemically important NTNIactivities).• Increased resolvability:The FSB’s “Key Attributes for Effective Resolution Regimes” (KeyAttributes) would be the basis for improved resolvability and would helpreduce the impact of a G-SII failing. Under the Key Attributes, all G-SIIswill be required to produce recovery and resolution plans (RRPs) withtheir supervisor.The G-SII authorities will also be required to establish a crisismanagement group (CMG), conduct resolvability assessments and havecooperation agreements with other involved supervisors.• Higher loss absorption (HLA) capacity:This will entail the supervisor requiring the G-SII to hold moreregulatory capital or to increase loss absorption capacity by other means.Higher capital will be targeted at those NTNI activities the G-SIIundertakes which generate systemic risk if, and to the extent to which, _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 82. the G-SII has demonstrated effective separation of NTNI activities fromtraditional insurance activities.It is noted that some national supervisory frameworks are expected toprovide for capital surcharges that account for the systemic risk profile ofan insurance group and these additional capital requirements would betaken into consideration in assessing whether the G-SII has anappropriate level of HLA capacity.11. When applying policy measures authorities should keep the followingpoints in mind:• Measures should be proportionate and should avoid unintendedadverse consequences, where practicable• Measures should be directed at the source of systemic importance andlinked to the assessment methodology• Measures will often require strong cooperation among authorities,including authorities with responsibility for non-insurance entitieswithin the insurance group.3.2 Enhanced supervision3.2.1 General description12. Enhanced supervision of G-SIIs will generally mean, in line with theSIE recommendations, specifically tailored regulation, greatersupervisory resources and bolder use of existing supervisory toolscompared to the supervision of non-systemically important insurers.The enhanced supervision of G-SIIs should include a direct approach toconsolidated group-wide supervision and should especially focus on theunique risk profile and possible risk concentrations of G-SIIs in order tolessen the probability and impact of failure. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 83. In doing so, involved supervisors should take into account the reasonsfor the systemic importance of the G-SII suggested by the results of G-SII assessment methodology.13. The desired outcomes of enhanced supervision are:• The supervisor determines a set of measures to reduce the risks posedby the G-SII and establishes timelines and indicators to adequatelymonitor the effectiveness of the measures.• There is a group-wide supervisory framework that applies to the groupas a whole with a particular focus on its systemic risks and the need forcooperation among supervisors, including supervisors withresponsibility for non-insurance entities within the insurance group.Obstacles that could hinder effective group-wide supervision areidentified and removed.For G-SIIs, the supervisor has direct powers over holding companies toensure that a direct approach to consolidated group-wide supervisioncan be applied.• The supervisor has clear visibility of internal control systems and riskmanagement and solvency assessment procedures within the insurancegroup.This includes requiring the G-SII to have the ability to aggregate andidentify risk exposures and concentrations quickly and accurately at thegroup-wide level, across business lines and legal entities, and to otherfirms.• The G-SII has internal controls and limits that are appropriate,investments and reinsurance arrangements that are appropriatelydiversified, increased disclosure and additional stress testing.• Enhanced supervisory co-ordination is achieved via supervisorycolleges (cross-sector and cross-jurisdictions). _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 84. 14. The IAIS approach to enhanced supervision builds on:• The IAIS ICPs, which are applicable to all insurers and will be thefoundation for the G-SII policy measures.• The IAIS ComFrame, which will aim to foster global convergence ofregulatory and supervisory measures and approaches for InternationallyActive Insurance Groups (IAIGs), whether or not they are identified asG-SIIs, although ComFrame is not expected to directly focus onaddressing systemic risk.• Special attention should be paid to group-wide supervision since G-SIIs are most likely to take the form of a group and NTNI activities areoften carried out by separate entities within a group.• The FSB’s recommendations for “Intensity and Effectiveness of SIFISupervision”, (SIE recommendations), especially in relation to:– Unambiguous mandates, independence and appropriate resourcesMandates geared toward active early intervention can facilitate a culturewhere supervisors have the will to act early.The mandate should convey the point that the supervisory authority’srisk view of a firm will always reflect a higher degree of conservatism andwill therefore often be a source of conflict when viewed against therespective risk appetites of senior management, board and shareholders.Reinforcing the operational independence and resources of supervisoryagencies is critical to ensuring supervisory effectiveness and credibilityin general.Supervisor independence is of particular importance as the mandates ofagencies is broadened to include authority to take countercyclicalactions such as imposing more conservative underwriting standards inboom times, or raising capital requirements, which may run contrary topublic perceptions of risk and be politically unpopular. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 85. – Full suite of supervisory powersSince the crisis, the need for tools such as increased liquidityrequirements, large exposure limits, imposing dividend cuts, requiringadditional capital etc. have come to the forefront.Given that a full suite of powers is critical to a supervisor executing theirrole, the inventory of required tools should be updated. Supervisors needto ensure that the stress testing undertaken is comprehensive andcommensurate with the risks and complexities of these institutions.– Improved standards and methodsIncreased focus on outcomes of governance and business processes andgreater use of horizontal reviews are desirable.Supervisors need to evaluate whether their approach to and methods ofsupervision remain effective or have, for example, moved too far towardfocusing on adequacy of capital and control systems, and away fromdetailed assessments of sources of profits and financial data.Supervisory interactions with Boards and senior management should bestepped up, in terms of frequency, level of seniority, and assessment oftheir effectiveness.Consideration should be given to developing expanded guidance tosupervisors on how to assess a board with the goal of being better armedwith tools and techniques which enable better determination of boardeffectiveness.Supervisors should adopt proactive approaches to deal with successionplanning and performance expectations for key positions within G-SIIs(e.g. CEOs, CROs, Internal Auditors), elements that should no longer beregarded as only internal matters for institutions.– Stricter assessment regime _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 86. Supervisors should consider how their supervisory frameworks setinternal control expectations (including risk management frameworks)for G-SIIs, and they should be confident that the assessment criteria forthe control environment at G-SIIs set a “higher bar” for these firms toachieve in the areas of internal controls given the potential systemicimpact that they pose.Supervisors should further explore ways to formally assess risk culture,particularly at G-SIIs. Establishing a strong risk culture at financialinstitutions is an essential element of good governance.– Group-wide and consolidated supervisionGroup-wide supervisory work can be impaired when supervisors do nothave the legal right or ability to review the group entities including non-regulated entities (including parents and/or affiliates), yet those entitieshave the potential to pose risks to the regulated entity.Consolidated supervisory blind spots can be created when there areentities within the regulated firm that the consolidated supervisor doesnot have access to or influence over.In some cases this is caused by business lines that have a primarysupervisor that is different from the primary supervisor of theconsolidated entity.Competing mandates and approaches of these supervisors can fragmentthe overall supervisory effort.– Risk aggregationSupervisors should study their data needs and data processingcapabilities in the context of the higher requirements for G-SIIsupervision.Where there are deficiencies in any or all of _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 87. i) The type of data collected,ii) The authority’s ability to process the data in a timely and fulsomeway, oriii) Their ability to collect ad-hoc data in a timely manner, these shouldbe addressed as soon as possible.Supervisors need to consider putting in place additional datamanagement and analysis processes for the information available from arange of sources, such as that collected by trade repositories and othercentralised sources of financial data, so that key players in markets andmarket anomalies are identified.3.2.2 Enhanced liquidity planning and management15. The supervisor should require the G-SII to have adequatearrangements in place to manage liquidity risk for the whole group,primarily in relation to NTNI activities and key channels ofinterconnectedness and secondarily also for the remainder of the group.These arrangements should include written strategies and policies forliquidity risk management during normal and stressed conditionssubject to clearly documented governance requirements.Adjustments for expected behavior of market participants and customersduring stressed conditions (especially in relation to acceleration ofliabilities) should be considered.Liquidity risk management policies should include all relevant issues.Relevant issues may include: the basis for managing liquidity (forexample, regional or central); the degree of concentrations, potentiallyaffecting liquidity risk, that are acceptable to the firm; a policy formanaging the liability side of liquidity risk and potential effects ofdowngrades on rating triggers; the role of marketable, or otherwise _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 88. realisable, assets; ways of managing both the firms aggregate foreigncurrency liquidity needs and its needs in each individual currency; waysof managing market access; the use of derivatives to minimise liquidityrisk (including potential for collateral calls and margin calls); and, ifNTNI activities exist, the management of intra-day liquidity.3.2.3 Structural measures and the Systemic Risk Reduction Plan(SRRP)16. The authorities should analyse activities that cause systemicimportance of G-SIIs and take necessary measures to reduce thatsystemic importance.The authorities should select the most effective policy measures toachieve this goal.The authorities should oversee the development of a SRRP by each G-SII (in addition to the recovery and resolution plans (RRPs)) to reducethat systemic importance and monitor implementation of the plan.Where feasible and appropriate, the SRRP may include effectiveseparation (so as to achieve self-sufficiency) of systemically importantNTNI activities from traditional insurance business (in combinationwith targeted HLA) and/or restrictions or prohibitions of specifiedsystemically important activities or any other measures.3.2.3.1 Separation of non-traditional and non-insurance (NTNI)activities17. Separation of NTNI activities is an ex-ante policy measure aiming forgreater transparency, self-sufficiency and resolvability of G-SIIs bytargeting the structure of G-SIIs.The desired outcomes of implementing this measure are: _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 89. • Traditional insurance business is more strongly shielded from NTNIbusiness and vice versa. The qualities and resilience of traditionalinsurance business can be largely preserved20, even in G-SIIs with lesstraditional operations.• The resolvability of G-SIIs is structurally improved ex-ante, unlikeRRPs which are conceived ex-ante but executed ex-post.The resolvability of traditional insurance business can be largelypreserved, even in G-SIIs with less traditional operations, and theresolvability of NTNI business is addressed. (see 3.3 EffectiveResolution)• (In combination with targeted HLA) the expected impact of thedistress or failure of the NTNI entities is reduced to non-systemic level.18. The aforementioned outcomes are supported by the followingcombination of specific measures:• NTNI business is conducted in separate legal entities that arestructurally and financially self-sufficient– Structural self-sufficiency means that it should be possible to ring-fence (and liquidate) self-sufficient legal entities without impacting theremaining legal entities of a group.As well as legal entity separation, it requires that problematic NTNIintra-group transactions such as guarantees (especially any unlimitedguarantees, upward and peer guarantees and intra-group transactionsaimed at capital gearing) as well as cross-default clauses are prohibitedor at a minimum adequately monitored and restricted.– Financial self-sufficiency requires economically adequatecapitalisation of legal entities that account for their systemic importanceand hence of the G-SII; avoiding certain structures designed to allow forundercapitalisation and subsidies of selected legal entities. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 90. • Subsidies in the form of capital and/or funding to the benefit of NTNIentities should not be allowed• Self-sufficiency in terms of structure and financial condition is to bemonitored and verified by the authorities during the process ofimplementation of the SRRP.19. Company structures exist in such a variety of forms that it isimpossible to capture the structural measures in a set of all-encompassing rules.The structure of G-SIIs becomes more transparent and hence tractablewith their businesses separated according to the business segmentsproposed in Insurance and Financial Stability.This allows supervisors to target their supervisory actions and measuresmore effectively and efficiently to the nature and risks of the respectivebusiness segments.In terms of tractability and transparency, the organisational structure ofG-SIIs would be simpler to understand if different types of activities andbusinesses were compartmentalised.The financial statements would also be simpler to understand if segmentreporting is aligned accordingly.20. The authorities should avoid the creation by the G-SII of non-regulated entities through the separation of NTNI activities.Any entities used to separate NTNI activities should be effectivelyregulated under direct consolidated group-wide supervision includingcoordination with other involved supervisors, as discussed above. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 91. 3.2.3.2 Restrictions and prohibitions21. The supervisor could choose to apply restrictions and prohibitionswith the following goals in mind:- to reduce the probability and impact of failure resulting from systemically important activities within G-SIIs- to eliminate or limit systemically important activities based on the nature of the activity- to discourage such activities and thereby encourage G-SIIs to reduce or eliminate their systemically important activities and discourage other insurers from undertaking potentially systemically important activities.22. Restrictions and prohibitions are most effectively applied to NTNIand interconnectedness activities and could be applied on a stand-alonebasis or in combination with other policy measures.Restrictions and prohibitions could be targeted to specific legal entitieswithin the G-SII or they could be tailored to specific systemic NTNIactivities or those activities that make a company more interconnected.23. Restrictions and prohibitions cover a broad range of options thatinclude both direct prohibitions, limitations and restrictions on activitiesas well as measures that provide strong disincentives and/or internalisethe costs for engaging in systemically important activities.These include:• Direct prohibition or limitation of the systemically important activity• Requirements for prior approval of transactions that fund or supportsystemically important activities _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 92. • Requirements for spreading or dispersing risks relating to systemicallyimportant activities.• Limiting or restricting diversification benefits between traditionalinsurance business and other businesses.This measure improves the overall capital position and hence providesHLA capacity.In practical terms, it could either be applied at ultimate parent level or atthe NTNI sub-holding or entity level24. Given the premise that insurers are not likely to inherently generatesystemic risk other than through NTNI and interconnectedness,prohibitions or strict limitations of an activity can be applied to G-SIIswhere the goal is to eliminate the activity or severely curtail the riskyactivity.When a systemically important activity is conducted by a non-insuranceentity within a group and joint banking and insurance make it moredesirable to contain the risk rather than remove the activity, restrictionmay play a lesser role when compared with structural measures (e.g.segregation or separation) and HLA capacity.3.3 Effective Resolution25. The desired outcomes of effective resolution are:- to ensure the resolution of G-SIIs can take place without severe systemic disruption and without exposing taxpayers to loss,- to protect vital economic functions through mechanisms which make it possible for shareholders and unsecured creditors to absorb losses in a manner that respects the hierarchy of claims in liquidation, _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 93. - to ensure that policyholder protection arrangements remain as effective as possible,- to avoid unnecessary destruction of value and ensure that non-viable G-SIIs can exit the market in an orderly way, and- to identify and remove impediments to smooth resolution.3.3.1 Resolution regimes and tools for G-SIIs26. In 2011, the FSB published an international standard for resolution –“Key Attributes of Effective Resolution Regimes for FinancialInstitutions” (Key Attributes).This standard sets out a range of specific requirements for institutionsthat should apply at a minimum to all G-SIFIs including G-SIIs.They include(i) The establishment of Crisis Management Groups (CMGs);(ii) The elaboration of recovery and resolution plans (RRPs);(iii) The conduct of resolvability assessments; and(iv) The adoption of institution-specific cross-border cooperationagreements.27. To carry out an effective resolution, authorities need to have at theirdisposal a broad range of tools that enable them to intervene safely andquickly to protect policyholders and avoid destabilisation of financialmarkets.At present, many IAIS jurisdictions have a fourfold power in connectionwith the trigger points of a recovery system to require a solvency plan ifthe “prescribed capital requirement” (PCR) is breached, a financing _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 94. plan if the “minimum capital requirement” (MCR) is breached, arecovery plan if the asset/liability ratio is breached and a liquidationplan if both the asset/liability ratio and the MCR are breached.These powers should be considered for RRPs of G-SIIs when they are ingood health.The FSB Key Attributes should serve as a point of reference for thereform of national resolution regimes, setting out the responsibilities,instruments and powers that all national resolution regimes should haveto enable authorities to resolve failing G-SIIs in an orderly manner andwithout exposing the taxpayer to the risk of loss.28. It needs to be further examined whether a mainly traditionalinsurance group with a large derivatives portfolio may experience adisorderly run-off and, if so, whether there needs to be adjustments tothe methodology or policy measures as a result.29. Authorities will consider and take all necessary actions to ensureeffective resolution including removing obstacles to the separability ofnon-traditional and non-insurance (NTNI) activities from traditionalinsurance activities during a stressed event.The resolvability assessment will include assessing whether, and theextent to which, effective ex ante separation of activities is in place. (See3.2.3 Structural measures and the SRRP).30. The FSB Key Attributes provide guidance to assist authorities inimplementing the requirements for G-SIFIs.The IAIS concurs that these requirements are also relevant for G-SIIs,although insurance specificities need to be taken into account inimplementing them.The FSB is currently developing an assessment methodology whichshould be used for assessments by the IMF and World Bank of nationalresolution regimes for financial institutions. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 95. The IAIS considers that the methodology should contain insurance-specific elements and hence is working closely with the FSB to ensurethat the methodology addresses insurance specificities.Where necessary, the IAIS will explore with its members the need todevelop further guidance for inclusion in the assessment methodology.Insurance specificities which need to be taken into account, include:• Plans and steps for separating NTNI activities from traditionalinsurance activities,• The possible use of portfolio transfers and run off arrangements as partof the resolution of entities conducting traditional insurance activities,and• The existence of policyholder protection and guarantee schemes (orsimilar arrangements) in many jurisdictions.31. The IAIS will also consider whether to develop a template forassessing resolvability of G-SIIs.This template could assist authorities in identifying structural measuresthat would better prepare G-SIIs for resolution if the G-SII needs to beresolved.The issues discussed under the previous section 3.2.3.1 on separationshould also be considered in this context.3.4 Higher Loss Absorption (HLA) capacity3.4.1 General description and purpose32. All G-SIIs should have higher loss absorption (HLA) capacity toreflect the greater risks that G-SIFIs pose to the global financial system.The desired outcomes of HLA capacity, all of which work to reduce theprobability or failure of distress and thus expected impact, include: _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 96. • The G-SII is more resilient to low probability but high impact events.• Supervisors intervene earlier than they would for non-G-SIIs givingthem more time to address emerging risks to the soundness of the G-SII.• Any implicit or explicit funding subsidy linked to G-SII status is offset.33. HLA can be applied as an instrument at the group level or as atargeted instrument at the legal entity level if, and to the extent to which,the G-SII has demonstrated effective separation of NTNI activities fromtraditional insurance activities.34. The application of HLA to G-SIIs is complicated by the fact thatthere is no global solvency standard for insurers.By requiring group-wide HLA, it might further aggravate differencesbetween jurisdictions which might result in further regulatory arbitragepossibilities.Furthermore, the international differences in accounting and regulatoryrequirements would need to be considered when deciding the basis forany calculations, with IFRS, US GAAP or Japan GAAP with bridges toIFRS as the basis.35. Mandating a higher loss absorption capacity for a G-SII will help toreduce its probability of failure.This is important given the greater risks that the failure of G-SIIs posesto the global financial system. The IAIS proposes that the followingcascading approach to achieve HLA capacity should apply.This is in line with the principle for HLA is to be targeted, wherepossible, at activities that have the potential to generate or aggravatesystemic risk.• Step 1 – if, and to the extent to which, the G-SII has demonstratedeffective separation (so as to achieve self-sufficiency) of NTNI activities _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 97. from traditional insurance activities, targeted HLA will be applied to theseparate entities conducting NTNI activities.• Step 2 – whether or not NTNI activities have been separated, an overallassessment of the HLA needed at the group level is required.In the case where Step 1 has been applied, this should take into accountthe HLA in the separate entities and the fact that separation exists, butonly where that HLA was not created by multiple-gearing through downstreaming capital within the G-SII.The group-wide supervisor determines (in consultation with involvedsupervisors) whether the HLA capacity held at the NTNI entities issufficient or needs to be further increased at the group level.• As an alternative to Step 2, there is on-going discussion within the IAISon whether there is a need for group-wide HLA if targeted HLA, andother measures (such as restrictions and prohibitions), are effective inreducing the level of systemic importance to an acceptable level.36. The HLA assessment will take into account any capital chargesimposed to mitigate the systemic risk of an insurer that are in placeunder national legislation.37. The structural measures required to achieve self-sufficiency arediscussed in the previous section 3.2.3.1 on separation.3.4.2 Methodology for applying group HLA capacity38. There is currently no global solvency standard for insurance groupsupon which to build HLA capacity requirements to apply consistentlyacross jurisdictions.Nevertheless, the IAIS has decided in November 2011 that the capitalcomponent of the solvency assessment in ComFrame should have,among other items, a partly harmonised set of standards and parameters _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 98. that sets out a narrow range of target criteria and time horizons formeasurement purposes.39. Currently, ICPs 17.3, 17.4 and 17.5 describe the concept of solvencycontrol levels which could be used as the basis for applying HLAcapacity.These ICPs specify a “prescribed capital requirement” (PCR), abovewhich level the supervisor does not intervene on capital adequacygrounds.The PCR should be set such that, in adversity, an insurer’s obligations topolicyholders will continue to be met as they fall due, that is, at a levelsuch that the insurer is able to absorb the losses from adverse events thatmay occur over a defined period while technical provisions remaincovered.HLA capacity would essentially be setting a higher PCR that accountsfor the fact that the failure or distress of a G-SII is associated withnegative externalities towards the global financial system and theeconomy, not just the policyholders and other direct stakeholders of theG-SII.40. HLA capacity could be applied to the current national/regionalsolvency regime, as an HLA uplift to the closest conceptual equivalent tothe PCR that is required under each country’s regulation.This approach should fit with most solvency regimes provided there isan equivalent of a PCR.Because it would be an add-on to the existing baseline solvencyrequirements in each jurisdiction, the large part of the overall solvencyrequirement should still be risk sensitive (to the extent that the existingregime is risk sensitive).This approach would also not impede the convergence of solvencystandards over time. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 99. Step 1 – Targeted HLA capacity41. If, and to the extent to which, the G-SII has demonstrated effectiveseparation (so as to achieve self-sufficiency in terms of structure andfinancial condition) of NTNI activities from traditional insuranceactivities, targeted HLA will be applied to the separate entitiesconducting NTNI activities.Thus it sits where it is most needed in situations of stress.Targeted HLA capacity establishes an additional capital buffer and alsomakes it more expensive to carry out systemic activities. It is specificallyaimed at the systemic NTNI business of insurers and is a disincentive asG-SIIs would require more capital.42. Targeted HLA could directly affect the activities that pose systemicrisk within the insurance business and also provides incentives toundertake any activities that pose systemic risk to a lesser extent.43. For any banking or bank-like activities, whether carried out in a banksubsidiary or a non-insurance financial entity, the targeted HLA capacitycould be set according to Basel III rules (eg HLA of at least 1% of risk-weighted assets).Where Basel III can be used, it should be carefully designed to avoidregulatory arbitrage by applying the same rule to the same activity.Moreover, the same standards should apply to the same business indifferent jurisdictions to ensure a level playing field.44. For other NTNI activities, the supervisor would need to determinesuitable rules based on the nature of the activities and the principles inthe ICPs and other relevant regulatory frameworks.The IAIS will provide guidance for supervisors as part of the proposedconcrete policy measures on HLA, by the end of 2013. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 100. Step 2 – Group-wide HLA capacity45. Under Step 2, an overall assessment of the HLA needed at the grouplevel is required.In the case where Step 1 has been applied, this should take into accountthe HLA in the separate entities and the fact that separation exists, butonly where that HLA was not created by multiple-gearing through downstreaming capital within the G-SII.Possible add-ons should also be considered. Ideally, the level of group-wide HLA capacity should reduce the expected impact of a G-SII failingto an agreed benchmark.One way to set the appropriate level of group-wide HLA capacity wouldbe so that the probability of failure is reduced to the point that theexpected impact of a G-SII failing equals the expected impact of othersimilar insurance groups thatare not G-SIIs failing. This approach is not considered feasible in theshort term, as there is not sufficient data available to make a properassessment.Application of the HLA uplift46. Deciding a basis to calculate the HLA uplift is complicated bydifferent solvency regimes and accounting requirements acrossjurisdictions.Two options on which the HLA uplift could be based are to use a capitalmeasure or a balance sheet measure:i) Capital measure based on existing local solvency regimes _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 101. The capital measure could be the nearest equivalent solvency standardto the PCR and the HLA uplift would be a percentage of the PCR(possibly in the range of 10% to 30%).Advantages:• Simple to handle.• Consistent with the concept of PCR which is the baseline of HLAuplift.Disadvantages:• As the baseline of group-wide HLA capacity is different, distortionscould occur, depending on what business is being taken into accountunder local regimes and whether the major part of the business lies injurisdictions with higher or lower regulatory capital requirements.• Aggregation of local regimes may not create a sufficient capitalmeasure or, conversely, may provide an excessive capital measure.• Most local regimes will have little or no regard for specific treatment ofNTNI activities.ii) Total balance sheet (including off-balance sheet positions)The balance sheet measure could be based on the total balance sheet(excluding capital but including off balance sheet items) and the HLAuplift would be a percentage of that amount (possibly in the range of0.5% to 1.5%).It should be considered whether and how to deduct insurance assets andinsurance liabilities in an appropriate manner in order to dis-incentivisereductions in insurance technical reserves and related assets.Advantages: _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 102. • More global approach• Improves comparability between G-SIIs provided IFRS, US GAAP orJapan GAAP with bridges to IFRS are used as a basis• Independent from the levels of regulatory capital, and hence mayprovide more consistency between jurisdictions than the previousapproach.Disadvantages:• Not as precise as a fully-fledged economic capital regime.• Not risk-sensitive, and could be inconsistent with an insurers riskmanagement framework.• Accounting differences across jurisdictions in the calculation ofinsurance liabilities mean this approach could also yield considerableinconsistency of HLA uplift.• This approach penalises insurers with healthier balance sheets withinjurisdictions, including those insurers that maintain more conservativetechnical provisions.• It is technically difficult to define off-balance sheet items.3.4.3 Acceptable instruments47. Currently, there is no common global definition of capital in theinsurance sector.The ICP 17.11.34 provides an example of broad categorisation of capitalas follows. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 103. a. Highest quality capital: permanent capital that is fully available tocover losses of the insurer at all times on a going-concern and a wind-upbasis;b. Medium quality capital: capital that lacks some of the characteristicsof highest quality capital, but which provides a degree of loss absorptionduring on-going operations and is subordinated to the rights (andreasonable expectations) of policyholders;c. Lowest quality capital: capital that provides loss absorption ininsolvency/ winding-up only.48. The FSB report, endorsed at the G20 Seoul Summit in November2010, states that G-SIFIs should have greater loss absorption capacitywhereby a higher share of their balance sheets is funded by capitaland/or by other instruments which increase the resilience of theinstitution as a going concern.49. In line with the FSB recommendation, given the going-concernobjective of the HLA capacity requirement, the HLA capacity should bemet by the highest quality capital as defined in the above-mentionedICP17.11.34.Instruments comprising the highest quality capital – that is permanentcapital that is fully available to cover losses of the insurer at all times ona going-concern basis – are the appropriate instruments to meet a HLAcapacity requirement for the time being.50. The supervisor should judge whether an instrument which exists inits jurisdiction constitutes the highest quality of capital or not.It should also be noted that the IAIS has decided that a commondefinition of capital resources is to be established by 2013.51. Attention should be paid to the fact that the additional capital shouldsit in the place where it is most needed (e.g. in separate NTNIbusinesses). _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 104. Otherwise, particularly if sitting in non-regulated entities (e.g. holdingcompanies), issues relating to supervisory powers as well as transferimpediments might arise.3.4.4 Refining the HLA capacity requirement52. The IAIS will elaborate the above-mentioned HLA capacity measureand develop a concrete proposal by the end of 2013 taking into accountthat a sufficient transitional period of the introduction of this measurehas been proposed as implementation is scheduled to begin from 2019(see section 4).4 Implementation4.1 Implementation timeframe53. The starting point for the implementation of G-SII policy measures isthe public determination by the FSB and national supervisory authoritiesthat a particular insurer is found to be a G-SII.For each G-SII, the group-wide supervisor would contact the G-SII tocommence the process of implementing required policy measures.The key dates and timeframes are expected to be: _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 105. 54. Discussions with the G-SII would focus first on the particular driversof G-SII status.The authority would immediately begin to implement measures withregards to enhanced supervision (including development of the SRRP)and effective resolution.The SRRP and resolution measures should be completed within 18months after G-SII designation. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 106. The implementation of the SRRP should be assessed by the authorities 3years after G-SII designation.Implementation of the SRRP is a prerequisite for application of thetargeted HLA capacity requirements.55. Regarding the proposed policy measures on HLA, the IAIS willelaborate and develop a concrete plan by the end of 2013.56. The HLA capacity requirements will apply from 2019 for those G-SIIsdesignated in 2017 and will be based on the status of implementation ofthe SRRP in 2017.The list of designated G-SIIs will be updated every year.After the first designation in 2017, a newly designated G-SII will beallowed to have the same period to meet the HLA capacity requirement.57. The IAIS expects national authorities to prepare a framework inwhich insurers will be able to provide high quality data for theindicators.To ensure the transparency of the methodology (for the benefit of marketparticipants and to promote market discipline) and the efficientidentification of G-SIIs, the IAIS expects all participating insurers todisclose relevant data when the G-SII policy is implemented and theIAIS will provide reporting guidance.58. Implementation of G-SII policy measures should be monitored by anIAIS peer review process in order to ensure international consistency. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 107. EIOPA Work Programme 2013EIOPA Work Programme 2013 describes thegoals and deliverables for EIOPA in its third yearof operation.EIOPA has decided to reshape the structure ofits Work Programme, following therecommendation from the European Court ofAuditors, aligning it with the tasks that theRegulation settling EIOPA assigns to theAuthority.Such change in structure has not affected thehighly ambitious programme presented for 2013,nor the high quality internal standards thatinform and guide all EIOPA deliverables.The content of this Work Programme is driven by EIOPA role towardsSupervisory and Regulatory Convergence, the core importance thatConsumers have in EIOPA strategy and Mission, and the active role inthe field of Financial Stability and Crisis Management.Relevant projects such as Solvency II will be reshaped, with a clear shiftfrom regulation to supervision.Other areas of work, in particular in the field of pensions, will demandsignificant efforts from EIOPA in terms of sound and qualitydeliverables to the European Commission in the frame of their projectedenhancement of pensions regulation.Supervisory tasks, and their convergence, rank high among EIOPApriorities.Concrete deliverables such as a supervisory handbook, an internalmodels support expert unit, or an enhancement of the role and scope ofthe colleges of supervisors will be provided during 2013. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 108. External relations, within Europe and outside, will continue playing asignificant role in EIOPA deliverables.EIOPA places great value on the formal opinions, and othercontributions, made by its two stakeholder groups for insurance and foroccupational pensions.In addition to its sectoral work, EIOPA’s Chair will take theChairmanship of the Joint Committee of ESAs.All these developments will entail a further growth of the organisation, interms of budget and resources.Staff number, if the Budgetary Authority agrees to the request of EIOPA,will grow up to 112, to achieve the objectives and deliverables set in thisWork Programme.Priorities still have to be made with regards to EIOPA mandate, as theAuthority will only reach its anticipated size in 2020.For 2013, according to EIOPA proposal, the budget will grow from 15.6to 20 million Euro, with a share of 40% from the Commission and 60%from its Members.If at the end of the budgetary process EIOPA’s budget would not reachthe aforementioned figure, the Work Programme would be reprioritizedand some of the deliverables today incorporated would have to bepostponed.These deliverables are marked green in Annex I of the WorkProgramme.The language versions of the document’s main part will be madeavailable at a later stage. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 109. InsuranceThe European insurance market is the largest in the world.Given its importance there will be substantial benefits from theintroduction under Solvency II of a Europe-wide harmonised frameworkwhich provides the right incentives for insurers to better understand,measure and manage their risks.EIOPA has already achieved a great deal in the preparation for SolvencyII.EIOPA is currently consulting on the technical standards and guidelinesin order to complete the legislative framework for Solvency II.Its last quantitative impact study (QIS5) of the impact of Solvency II wasthe most ambitious and comprehensive impact study ever carried out inthe financial sector, involving more than 2,500 insurance companies.It has provided technical contributions during the political discussionson key aspects of Solvency II such as long term guarantees andreporting.It is already carrying out assessments of whether third countries’insurance frameworks are equivalent to those of the EU’s.In 2013 EIOPA will finalise the standards and guidelines whichinsuranceundertakings require as part of the Solvency II framework.These will comprise the 53 standards and guidelines mandated bylegislation and on its own initiative a guideline on external scrutiny oraudit for the purposes of Solvency II publicly disclosed information.The standards and guidelines will cover the solvency capitalrequirements, own funds, internal models, group supervision,supervisory _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 110. transparency and accountability, reporting and disclosure, valuation, thevaluation of assets and liabilities other than technical provisions, andgovernance.In 2013 EIOPA will also continue to identify, scope and implement theoperational tasks required of it under Solvency II.This includes the following- Publishing a list of authorised firms,- Collecting and publishing a report about the use of capital add-ons and the extent to which they are consistently applied across member states- Deriving and publishing the risk free rate.- Mapping the ratings of External Credit Assessment Institutions.- Publishing lists of typologies of regional governments and local authorities, exposures to whom are to be treated as exposures to the central government.- Specifying adjustments to be made for currencies pegged to the euro.- Choosing the equity index for the equity dampening mechanism- Determining, at the request of national supervisory authorities or on its own initiative, the existence of an exceptional fall in financial markets for the application of the extension of the SCR recovery period- Reporting to the European Parliament on the functioning of supervisory colleges and the appointment of the group supervisor.These specific operational tasks are accompanied by generic tasks whichhave been given to EIOPA as part of the new supervisory structure. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 111. This includes the power for binding mediation, further work onequivalence assessments, and membership of colleges of supervisors.EIOPA will consider what should be the configuration of workinggroups and other mechanisms to deliver this next phase of insuranceregulation.On its own initiative EIOPA will also deliver the following during 2013:- Start working on best practices with respect to aspects of the Supervisory Review Process for supervisors as a practical step to contributing to a common supervisory culture among supervisors- Develop a centre of expertise on the use of internal models under Solvency II- Collect data in EIOPA for further use for the purposes of financial stability and micro-prudential analysis, as part of implementing EIOPA’s database strategy EIOPA will continue in 2013 to build links between the Solvency II framework and other areas.It will complete the current assessments of equivalence of third countriesand begin to assess the impact on consumer choice of the solvency IIframework.EIOPA’s plans are naturally dependent on political and otherdevelopments, especially with respect to the quantitative supervisoryframework.EIOPA will also enter a process of maintenance of its standards andguidelines; this maintenance includes:- The revision of standards and guidelines already published.- The potential drafting of additional guidelines and recommendations, _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 112. following the further needs which might be identified throughcommunication with stakeholders and National Supervisory Authorities.CollegesColleges of Supervisors (Colleges) are considered efficient and effectivetools used in supervision of financial institutions, and they are essentialinstruments to enhance mutual understanding among supervisors andconvergence of supervisory practices, with tangible benefits toundertakings, supervisors and policyholders.The overall strategic target of EIOPA’s college work is to build theposition of the EEA supervisory community towards the cross borderoperating insurance groups for the benefit of both group and solosupervision.The focus is on combining and leveraging the knowledge and forces ofthe National Supervisory Authorities in the EEA to form a strong andequal supervisory body to effectively deal with centrally organized andmanaged undertakings.According to EIOPA Regulation, day to day supervision as well as theset up and organisation of the Colleges is the responsibility of theNational Supervisory Authorities.EIOPA as a member of Colleges promotes communication, cooperation,consistency, quality and efficiency in Colleges and provides oversight.EIOPA established in 2011 and reinforced in 2012 a highly qualifiedCollege Team and each staff member has a portfolio comprising severalColleges.This allows EIOPA to cover all 93 colleges currently active in Europe,targeting physical participation in at least 70 colleges of supervisorsduring 2013. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 113. EIOPA expects that the added value brought by EIOPA into theColleges and activities of the Colleges will have improved considerablyin 2012 and in 2013 the participation of EIOPA Staff in the Colleges canbe consolidated.When monitoring the functioning of Colleges, the result will form thebasis of EIOPA’s Action Plan for Colleges 2013 and include measurable,realistic, and at the same time ambitious goals.As for the 2012 Action Plan, the performance of individual colleges onthe agreed deliverables will be made public.In 2013 EIOPA will: - Promote specifically the finalisation of the preparation of the Colleges for Solvency II, e.g. coordination agreements are expected to be agreed by year-end 2013 by all Colleges- EIOPA staff will continue as a Member in the Colleges to advise Group Supervisors and Colleges on the possibilities to improve the functioning of their College. Practical solutions and examples of supervisory practices will be collected- Develop best practices on specific topics with a particular focus on delegation of tasks amongst supervisors- To promote a common understanding of the group’s risk profile within Colleges, EIOPA will prepare for a data collection and analysis system for peer comparisons as a support function to Colleges _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 114. Hearing before theCommittee on Economicand Monetary Affairs of theEuropean ParliamentIntroductory statement by , Chair of the ESRB, BrusselsDear Madam Chair,Dear HonourableMembers,I am very pleased to appearbefore this Committeetoday to inform you aboutthe activities of theEuropean Systemic RiskBoard (ESRB).As you know, the ESRB complements the know-how of central banks,national supervisors and the three European Supervisory Authorities bydelivering what has come to be called a macro-prudential perspective.What this means is the capacity to analyse risks across market segments,to address vulnerabilities – which currently lie mainly in the bankingsector – and to examine medium-term risks in the financial system as awhole.Based on such analysis, combined with proposals for remedial action byway of warnings or recommendations, the ESRB will help to protectEurope’s economy from fragility in the financial system.An important step in the ESRB’s work was the publication of the firstrisk dashboard on 20 September 2012. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 115. The dashboard was requested by this Parliament in the legislativeprocess establishing the ESRB.It consists of a set of quantitative and qualitative indicators aimed atidentifying and measuring systemic risk.The risk dashboard has been produced in cooperation with theEuropean Central Bank (ECB) and the three European SupervisoryAuthorities (ESAs).It is one of the inputs considered by the ESRB’s General Board in itsdiscussions of risks and vulnerabilities in the financial system.The dashboard, which will be updated quarterly, looks at six differentcategories of risks, sectorally and across the financial landscape.It should be considered an information tool that orients further analysison systemic risk, rather than a fully-fledged early warning system.The General Board has decided to publish the dashboard and itsunderlying data on the ESRB’s website.Risks in the banking sectorLet me turn to the current situation.The European economy and financial system continue to facechallenging times – and it is vital always to be mindful of systemic risks.But there are also reasons to be confident, provided that policy-makerscontinue to implement agreed measures with determination.These measures include macroeconomic and structural reforms toensure competitiveness and sustainable public finances.They include continued financial reform to ensure a resilient and well-functioning financial system. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 116. And they include further development of Europe’s institutionalframework.From a macro-prudential perspective, there are three main possiblerisks.First, the risk of setbacks in the implementation of agreed measures.Second, the risk of downside macroeconomic news with implications forbanks’ asset quality, profitability and funding.And third, the risk that feedback loops between these two factors mayaffect the supply of credit, which in turn will affect the real economy.Revitalising the supply of credit is crucial for the recovery.Notwithstanding some reductions in market tensions, financial activityremains impaired in various parts of the system.At this time, the role of macro-prudential policy is primarily to restoretrust in the financial sector.To rebuild investors’ confidence in banks, it is necessary to reassurethem about asset quality.There are a number of options that authorities can consider. One isenhanced disclosure, for example, on the level of provisioning.A second option is supervisory assessments of asset quality, possiblyincluding peer reviews by supervisors and third party assessments and athird option, where necessary, is the setting up of separate entities todeal with low quality assets.Important work is already being done by the European BankingAuthority (EBA), assessing forbearance in the banking sector,promoting coordinated reviews of asset quality and harmonisingdefinitions of key variables – such as non-performing loans. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 117. The ESRB plans to make further proposals for macro-prudential policy,particularly on vulnerabilities linked to bank funding.In light of the impairment of some credit and interbank markets, theESRB, together with the EBA, is reviewing asset encumbrance andcomplex funding instruments such as synthetic exchange-traded fundsand liquidity swaps.The aim is to identify sources of systemic risk and policy actions tomitigate them.I intend to present the results of this process at the next hearing in thefirst half of 2013.Risks in financial marketsThe ESRB’s examination of the financial system extends well beyondthe banking sector.Today, I would like to focus in particular on developments in the field ofcentral counterparties (CCPs) and over-the-counter (OTC) markets. Iwill outline the analytical work done by the ESRB and the policy adviceit has given.The implementation of the G20 commitment to central clearing for allstandardised OTC derivatives has important consequences for the EUfinancial system.The ESRB started to assess the systemic implications of the moreprominent role for CCPs that they will become a crucial node within thefinancial system.Macro-prudential examination of CCPs relates, in particular, to the pro-cyclicality of margining and haircutting practices. Such practices havean important bearing on financial conditions in the economy.While the more prominent role for CCPs reduces counterparty risk, itinevitably implies an increase in concentration risk. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 118. Therefore, the ESRB issued advice to the European Securities andMarkets Authority (ESMA) on two aspects regarding the systemicresilience of CCPs.On collateral, the ESRB advised the ESMA to increase the systemicresilience of CCPs by better defining the type of eligible collateral andthe conditions under which commercial bank guarantees may beaccepted as collateral by CCPs.The ESRB also advised that risks related to cross-collateralisation shouldbe adequately taken into account.On clearing among non-financial corporations operating in derivativemarkets, the ESRB advised the ESMA to restrict the possibilities forsuch corporations to settle outside CCPs, so as to reduce counterpartyrisk.Regrettably from a macro-prudential viewpoint, there is a risk that thesystemic vulnerabilities identified by the ESRB will remain at least partlyunaddressed.This is due to an interpretation of the EMIR legislation that has made itdifficult to translate fully the ESRB’s advice into technical standards.On OTC markets more broadly, the ESRB is examining potential risksstemming from market practices that have become very common in theso-called ‘shadow banking’ sector.For example, collateral pledged by a client may be re-used by a lenderfor own borrowing needs.This pattern, which is called re-hypothecation, may be repeated severaltimes for the same collateral.It can therefore create a contagion chain in case any party fails to deliver.In other cases, when collateral for securities lending transactions isrepresented by cash, that cash may re-invested by the lender. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 119. In case such re-investment takes place in a risky asset or for a longermaturity, there are risks of so-called reuse of cash collateral in securitiesfinancing transactions.Macro-prudential policies in the EUBanking union and the role of the ESRBThe ESRB has also reviewed the current plans on the banking union andwelcomes the European Commission’s proposal.Board members consider that the macro-prudential benefits of the SingleSupervisory Mechanism (SSM) would be enhanced if an adequateresolution regime for banks were implemented without substantial delay.The Commission’s initiatives for establishing a ‘single resolutionmechanism to resolve banks and to coordinate the application ofresolution tools to banks under the banking union’ are to be encouraged.The ESRB is reflecting on the implications of the proposed SSM for itsown work.The Commission’s proposal directly affects macro-prudential policy andits implementation – suggesting for the ECB exclusive competencewithin the euro area ‘to set counter-cyclical buffer rates and any othermeasures aimed at addressing systemic or macro-prudential risks in thecases specifically set out in Union acts’.The ESRB has repeatedly stressed that macro-prudential policies shouldbe sufficiently flexible to prevent the build-up of systemic risks.Policy-makers should be encouraged to mitigate emerging risks as soonas they are identified, rather than fostering a bias towards inaction.Flexibility can be balanced by members’ coordination to safeguardagainst potential negative externalities or unintended consequences. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 120. The ESRB is working on a general framework for the coordination ofmacro-prudential policies in the EU. First results can be expected in thecoming year.Meanwhile, a review of the mission and organisation of the ESRB itselfwill take place in 2013.Three members of the ESRB Steering Committee – Stefan Ingves, Chairof the Advisory Technical Committee, André Sapir, Chair of the AdvisoryScientific Committee, and Vítor Constâncio, Vice-President of the ECB– will examine the functioning of the ESRB, including in light of theforthcoming banking union.Follow-up on ESRB recommendationsThe ESRB is also working on first implementation of the ‘act or explain’mechanism set out in the ESRB Regulation to ensure that addresseesrespond properly to ESRB recommendations.The first set of deadlines for replies to the ESRB recommendationsissued in 2011 expired in June 2012.The current review suggests that the ‘act or explain’ mechanism hasfunctioned smoothly.At the same time, more work lies ahead to enhance our assessmentframework.The ESRB Secretariat has contacted relevant European and internationalinstitutions – such as the Commission, the IMF, the OECD, the FSBand the Bank for International Settlements – to learn from theirexperience.ConclusionsIn concluding, I would like to emphasise that there is substantialprogress in the understanding of systemic risks and the design of macro-prudential policies in the EU. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 121. This would not have been possible without the active involvement anddedication of all ESRB member institutions and committees.On the occasion of the rotation of the Chair of the Advisory ScientificCommittee, I would like to thank in particular its first Chair, MartinHellwig, and to wish all the best to the new Chair, André Sapir.I understand that you will have the opportunity to exchange views withthe Chair and Vice-Chairs of the Committee very soon. Thank you verymuch for your attention. I am now at your disposal for questions. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 122. Solvency II – monitoring the ongoingappropriateness of internal modelsJulian Adams, Director, InsuranceIn June 2012 I wrote to all firms in our internalmodel approval process to share our thinkingon the way we will monitor the ongoingappropriateness of internal models after approval.This letter gives an update on the development of early warningindicators and reiterates the purpose and intended use of the indicators.Our underlying concern is that, if not adequately monitored andupdated, the solvency standard delivered by internal models candeteriorate over time.The implementation of internal models inherently rests on a greatnumber of judgements and assumptions, both explicit and implicit.Our experience suggests that, over time, if models are not appropriatelyupdated, these assumptions and judgements can become lessappropriate, leading to an overall reduction in solvency standards.We therefore continue to develop early warning indicators to ensure thatthe Solvency Capital Requirement (SCR) will meet the Solvency IIcalibration on an ongoing basis.To achieve this objective, we believe that early warning indicators:a. should be based on metrics that are independent from the internalmodel calculations, i.e. not based on the firm’s modelled SCR;b. should be simple in their construction, calibration and application,avoiding complexity; and _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 123. c. will, if breached, trigger an immediate supervisory response; a capitaladd-on is, in all but exceptional cases, likely to be the most effective wayto restore compliance with the Solvency II calibration requirement (i.e.99.5% over a one-year period).We consider that the use of early warning indicators is consistent withthe supervisory powers set out in the Solvency II Directive and as suchwill form part of the supervisory review process for internal model firms.The early warning indicators would supplement information collectedfrom firms during the supervisory review process, including in particularthe results of model validation as well as any approval of changes to themodel.Further, the calibration of the indicators will aim to identify significantdeviations in firm risk profile with respect to the assumptions underlyingthe calculation of the SCR.Industry responsesWe received ten responses to our June 2012 letter. Overall, they focussedon how we will monitor the ongoing appropriateness of an internalmodel at the individual firm level.These are useful suggestions which we will take into account as part ofour supervisory review process.We also received some suggestions of an alternative indicator to theproposed ratio between the pre-corridor Minimum Capital Requirement(pMCR) and modelled SCR and we are investigating crediblealternatives.We did not receive any comments on the proposed industry sub-sectorsegmentation set out in the letter. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 124. Some respondents noted that the construction should also allow for thecapture of the underwriting cycle, and be mindful of the potential forpro-cyclicality and we will take this feedback into consideration infurther work.A number of respondents expressed support for a European approachand we have shared our thinking with EIOPA.I would like to confirm that we do not intend to use a multiple of thepMCR indicator, or any other early warning indicator, as a condition tothe approval of a firm’s use of an internal model.Our work with firms in the run up to implementation will inform thecalibration for the indicators at day one.As I said in my letter in June, we expect that, in the vast majority ofcases, firms submitting a model that properly reflects the firm’s riskprofile to the standard required by the Solvency II Directive, and whichis approved by us, will fall within the ratio or range of the indicator.So this should not be an issue for approved models on day one.Fundamentally, the purpose of the indicator is to limit subsequentdownward SCR drift relative to risk profile.We have set out our intention to review the indicators periodically, bothfrom our experience of their use and their calibration.In response to comments received that the early warning indicatorswould not allow for the reflection of the nature of and risks run byindividual insurers - we will not be providing calibration for indicators atan individual firm level as this runs counter to the policy approach tohave asimple, easy-to-apply indicator. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 125. Next stepsThere is still an opportunity for further engagement from the industry bycob Friday 26 October on early warning indicators that deliver the policyapproach set out above.We also welcome suggestions for the segmentation set out in the Juneletter.You can send your response to your usual supervisory contact or to medirectly.In the meantime we will be using data from firms to inform thedevelopment and calibration of early warning indicators.Yours sincerelyJulian AdamsDirector, Insurance _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 126. Solvency II: monitoring the ongoing appropriateness of internalmodelsAs part of our commitment to share developments in our approach to theimplementation of the Solvency II Directive, we wanted to set out ourthinking on the way in which we would monitor the ongoingappropriateness of internal models after approval.Model approval and beyondAs required by the Solvency II Directive, we will only approve an internalmodel for the calculation of the Solvency Capital Requirement (SCR) ifwe are satisfied that the systems for identifying, measuring, monitoring,managing and reporting risks are adequate and in particular if the modelfulfils the tests and standards set out in the Solvency II framework.While our focus is on the work we need to do to be able to give firms adecision on their internal model application in time for the first day ofthe regime, we are also looking ahead to how we use our knowledge andlearning to monitor the ongoing appropriateness of a firm’s internalmodel in the new regime.Following approval, firms are responsible for ensuring the ongoingappropriateness of the internal model, by ensuring that the internalmodel meets the tests and standards and reflects the firm’s risk profile.Firms should also ensure that the SCR is calibrated and corresponds tothe value at risk of their basic own funds of the firm, subject to aconfidence level of 99.5% over a one-year period.This means that we need to be assured that firms have put in placesystems which ensure that the internal model operates properly on acontinuous basis.We also need to be confident that the controls put in place are adequateand effective at all times, including stressed market conditions or crises. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 127. At a market level, we will monitor the movement of insurance sectorcapital over time.Our experience of internal models to date tells us that significant effort isput into an approval process, without adequate attention given toongoing appropriateness.This leads to a risk that standards of solvency deteriorate over time.Based on the requirements of the Solvency II Directive, it is ourexpectation that models will be monitored and updated regularly toreflect the firm’s risk profile and to ensure compliance with modelrequirements.Early warning indicatorsTo this end, we are developing a number of early warning indicatorsaimed at helping us and firms ensure that, after approval, internalmodels and the SCR calculation remain appropriate on an ongoingbasis, at both firm and system level and that firms’ internal modelscontinue to deliver outputs that are consistent with the requirements ofSolvency II.We will use the information provided by firms in their Solvency IIregulatory reporting to assess their position relative to these indicators(which may take the form of ratios or ranges) and so, the development ofthese indicators will not in itself create an additional reportingrequirement.However, firms will be required to notify us immediately in the eventtheir position falls outside these pre-determined ranges.In all but exceptional cases, we will take immediate supervisory action.This could include seeking a revision of the parameters and/orimposing a capital add-on. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 128. The aim of this action will be to increase the SCR so as to bring it onceagain above the indicator level with a view to ensuring that it complieswith the Solvency II calibration requirement (i.e. 99.5% over a one-yearperiod).In the meantime (and in any event), the firm and the FSA will worktogether to understand the issues better, which may result inimprovements to the firm’s model.We propose to use a number of early warning indicators to assist us withour monitoring of capital on a firm-specific and industry-wide basis.The indicators will be tailored to specific sectors of the insurancemarket.We will periodically review the indicators, both from our experience oftheir use and their calibration.Ratio between the pMCR and modelled SCROne of the indicators that we are currently developing is a ratio betweenthe pre-corridor minimum capital requirement (pMCR) and themodelled SCR.Separate pMCR indicators would be set at the level of an industry sub-sector to give us a high degree of assurance that the model is delivering acalibration at 99.5% over a one-year period.We intend to have indicators for firms which undertake:• life business, excluding with-profits business;• with-profits business;• general insurance business, excluding London market business; and _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 129. • London market business.Our preliminary analysis indicates that the pMCR indicator could rangebetween:• 175-200% for life business; and• 175-200% for general insurance business.We have used data from the fifth quantitative impact study, and appliedit to the latest version of the MCR specification set out in the November2011 draft Level 2 text to derive these preliminary ranges.However, to refine the calibration we will need information from UKfirms and we will issue a template and instructions in September 2012.Our intention is to calibrate the indicator so that, in the vast majority ofcases, firms submitting a model which properly reflects the firm’s riskprofile to the standard required by the Solvency II Directive and which isapproved by us will fall within the ratio or range of the indicator and sothis should not be an issue for approved models on day one.Fundamentally, the purpose of the indicator is to limit subsequentdownward SCR drift relative to risk profile.Since there is no MCR for groups, the ratio set out in this letter wouldapply to the UK solo entities.Next stepsIn addition to the request for data to refine the calibrations in September2012, we will also provide an update on the other early warning indicatorswe are considering to prompt supervisory intervention, including the useof stress tests and scenarios for economy-wide variables for with-profitsbusiness and groups. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 130. Yours sincerelyJulian AdamsDirector, Insurance _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 131. 16 October 2012 - Public Hearings on thedraft factual Report of the EU-USInsurance Regulatory Dialogue ProjectThe EU-US Insurance Regulatory DialogueProject organises two public hearings on thedraft factual Report based on the results of theProject’s seven technical committees (TC).The public hearings will take place:In the USA: on 12 October 2012 at 14.00 – 17.00 hrs EDT in the GrandHyatt, Washington DC;In Belgium: on 16 October 2012 at 10.00 – 13.00 hrs CET in the Centre deConférences Albert Borschette, Brussels.Requests to provide oral statements during the public hearings shouldbe sent by 10 October 2012 to the following email addresses:tom.finnell{at}treasury.gov (Washington Hearing) andManuela.Zweimueller{at}eiopa.europa.eu (Brussels Hearing). _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 132. The EU-US Dialogue ProjectThe EU-US Dialogue Project started in early 2012, when the EuropeanCommission (EC), EIOPA, the US National Association of InsuranceCommissioners (NAIC) and the Federal Insurance Office of the USDepartment of the Treasury (FIO) agreed to participate in dialogue anda related project (Project) to contribute to an increased mutualunderstanding and enhanced cooperation between the European Unionand the United States to promote business opportunity, consumerprotection and effective supervision.The objective of the Project, which builds on more than a decade of EU-US regulatory dialogue, is to deepen insight into the overall design,function and objectives of the key aspects of the insurance supervisoryregimes in the EU and the U.S, and to identify important characteristicsof both regimes.Request for the EU-U.S. Dialogue Project for Public Commenton the Technical Committee ReportsComparing Certain Aspects of the Insurance Supervisory andRegulatory Regimes in the European Union and the UnitedStatesTo Interested Parties:The Steering Committee of the EU-U.S. Dialogue Project invites publiccomment on the reports of seven technical committees comparingcertain aspects of the insurance supervisory regimes in the EuropeanUnion and the United States. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 133. Introduction to the EU-U.S. Dialogue ProjectIn the EU, the European Parliament, the Council of the European Unionand the European Commission (EC), technically supported by theEuropean Insurance and Occupational Pensions Authority (EIOPA), aremodernizing the EU’s insurance regulatory and supervisory regimethrough the Solvency II Directive (Directive 2009/138/EC), in placesince 2009.This so-called Framework Directive was the culmination of work begunin the 1990s to update existing solvency standards in the EU.Current work aims to further specify the Framework Directive withtechnical rules and guidelines, which are necessary for a consistentapplication by insurers and supervisors of the framework.In the United States, the states are the primary regulators of theinsurance industry.State insurance regulators are members of the National Association ofInsurance Commissioners (NAIC), a standard-setting and regulatorysupport organization created and governed by the chief insuranceregulators from the 50 states, the District of Columbia and five U.S.territories.As part of an evolutionary process, through the NAIC, state insuranceregulators in the U.S. are currently in the process of enhancing theirsolvency framework through the Solvency Modernization Initiative(SMI). SMI is an assessment of the U.S. insurance solvency regulationframework and includes a review of international developmentsregarding insurance supervision, banking supervision, and internationalaccounting standards and their potential use in U.S. insuranceregulation. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 134. In early 2012, the EC, EIOPA, the NAIC and the Federal InsuranceOffice of the U.S. Department of the Treasury (FIO) agreed toparticipate in dialogue and a related project (Project) to contribute to anincreased mutual understanding and enhanced cooperation between theEU and the U.S. to promote business opportunity, consumer protectionand effective supervision.The project is considered to be part of and builds on the on-going EU-US Dialogue which has been in place for over 10 years.The work is carried out in collaboration with EIOPA and competentauthorities in the EU Member States, and with state insurance regulatorsand the NAIC in the United States.The objective of the Project is to deepen insight into the overall design,function and objectives of the key aspects the two regimes, and toidentify important characteristics of both regimes.Project Governance and Process: The Project is led by a six-memberSteering Committee comprised of three EU and three U.S. officials, asfollows:• Gabriel Bernardino – Chairman of EIOPA• Edward Forshaw – Manager in the Prudential Policy division, UKFinancial Services Authority, and EIOPA Equivalence Committee Chair• Karel Van Hulle – Head of Unit for Insurance and Pensions,Directorate-General Internal Market and Services, EC• Kevin M. McCarty– Commissioner, Office of Insurance Regulation,State of Florida, and current President of the NAIC• Michael McRaith – Director, FIO, United States Department of theTreasury• Therese M. (Terri) Vaughan – Chief Executive Officer, NAIC _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 135. Since the Project began, the Steering Committee has held several face-to-face meetings in Basel, Washington DC and Frankfurt, as well asnumerous conference calls.In a first step, the topics to be discussed were agreed upon and a processfor information exchange under confidentiality obligations wasestablished.The Steering Committee agreed upon seven topics fundamentallyimportant to a sound regulatory regime and to the protection ofpolicyholders and financial stability.The seven topics are:• Professional secrecy/confidentiality;• Group supervision;• Solvency and capital requirements;• Reinsurance and collateral requirements;• Supervisory reporting, data collection and analysis;• Supervisory peer reviews; and• Independent third party review and supervisory on-site inspections.A separate Technical Committee (TC) was assembled to address eachtopic.Each TC was comprised of experienced professionals from both theEuropean Union as well as the United States, specifically, from FIO, theEC, the NAIC and EIOPA, as well as representatives from stateinsurance regulatory agencies in the United States and competentauthorities of EU Member States.The various professionals who comprised the technical committees wereselected because of their qualifications and experience with respect tothe subject matter of each topic, including insurance regulators andsupervisors, attorneys, accountants, examiners, and other specialists. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 136. The teams worked jointly to develop objective, fact-based reportsintended to summarize the key commonalities and differences betweenthe Solvency II regime in the EU, and the state-based insuranceregulatory regime in the United States.Supporting documentation, e.g., regulations, directives, and supervisoryguidance, was exchanged as requested by either side.The accompanying seven technical committee reports have been jointlydrafted and reflect the consensus views of each respective technicalcommittee’s members.No action has been taken by the governing bodies of the organizationsrepresented on the Steering Committee to formally adopt the draftfactual reports and thus this document should not be considered toexpress official views or positions of any organization.The reports represent the culmination of the initial work from the firstphase of the Project.The reports are being exposed for interested party analysis and commentand will inform discussions and conclusions reached by the SteeringCommittee on each topic during the second phase of the Project.It is envisaged that the second phase of the Project will involvediscussions of the Steering Committee about the key commonalities anddifferences between the two regimes and will lead to policy decisions bytheir respective organizations regarding whether and how to achievefurther harmonization in regulation and supervision.The project is scheduled to come to a conclusion by December 31, 2012. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 137. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 138. The Contributing PartiesThe Federal Insurance Office, U.S. Department of the TreasuryThe Federal Insurance Office (FIO) of the U.S. Department of theTreasury was established by the Dodd-Frank Wall Street Reform andConsumer Protection Act.The FIO monitors all aspects of the insurance industry, includingidentifying issues or gaps in the regulation of insurers that couldcontribute to a systemic crisis in the insurance industry or the UnitedStates financial system.The FIO serves on the U.S. Financial Stability Oversight Council.The FIO coordinates and develops U.S. Federal policy on prudentialaspects of international insurance matters, including representing theUnited States, as appropriate, in the International Association ofInsurance Supervisors.The FIO assists the Secretary in negotiating certain internationalagreements, and serves as the primary source for insurance sectorexpertise within the Federal government.The FIO monitors access to affordable insurance by traditionallyunderserved communities and consumers, minorities, and low- andmoderate-income persons.The FIO also assists the Secretary in administering the Terrorism RiskInsurance Program.The European CommissionThe European Commission (EC) is one of the main institutions of theEuropean Union. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 139. It represents and upholds the interests of the EU as a whole. The EC isthe executive branch of the EU and is responsible for proposing newEuropean laws to Parliament and the Council.The EC oversees and implements EU policies by enforcing EU law(together with the Court of Justice), and represents the EUinternationally, for example, by negotiating international tradeagreements between the EU and other countries.It also manages the EUs budget and allocates funding.The 27 Commissioners, one from each EU country, provide theCommission’s political leadership during their 5-year term.The National Association of Insurance CommissionersThe National Association of Insurance Commissioners (NAIC) is thestandard-setting and regulatory support organization created andgoverned by the chief insurance regulators from the 50 states, theDistrict of Columbia and five U.S. territories.Through the NAIC, state insurance regulators establish standards andbest practices, conduct peer review, and coordinate their regulatoryoversight that is exercised at the state level.NAIC staff supports these efforts and represents the collective views ofstate regulators domestically and internationally.NAIC members, together with the central resources of the NAIC, formthe national regime of state-based insurance regulation in the UnitedStates. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 140. European Insurance and Occupational Pensions AuthorityThe European Insurance and Occupational Pensions Authority(EIOPA) was established as a result of the reforms to the structure ofsupervision of the financial sector in the European Union.The reform was initiated by the EC, following the recommendations of aCommittee of Wise Men, chaired by Mr. de Larosière, and supported bythe European Council and Parliament.EIOPA technically supports the EC, amongst others, in themodernization of the EU’s insurance regulatory and supervisory regime.Current work aims to further specify the Solvency II FrameworkDirective with technical rules and guidelines, which is necessary for aconsistent application by insurers and supervisors of the framework. Incross-border situations, EIOPA also has a legally binding mediation roleto resolve disputes between competent authorities and may makesupervisory decisions directly applicable to the institution concerned.EIOPA is part of the European System of Financial Supervisionconsisting of three European supervisory authorities, the others beingthe national supervisory authorities and the European Systemic RiskBoard. EIOPA is an independent advisory body to the EC, the EuropeanParliament and the Council of the European Union.EIOPA’s core responsibilities are to support the stability of the financialsystem, transparency of markets and financial products as well as theprotection of insurance policyholders, pension scheme members andbeneficiaries. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 141. Annual public hearing of thechairpersons of the three EuropeanSupervisory Authorities (EBA, ESMA andEIOPA).Initial statement by Andrea Enria Chairperson of the EBA, infront of the Economic and Monetary affairs committee of theEuropean ParliamentDear Madame Chair, Honourable Members of this Committee,The sovereign debt crisis has had serious adverse consequences on thebanking sector in the euro area and the Single Market.The interconnection between banks and their sovereigns deepened,leading to a segmentation of the Single Market along national lines andto a dangerous volatility of deposits in some Member States.The concerns of investors translated into a freeze in bank funding,especially on the longer maturities, which could have triggered a massiveand disordered deleveraging process, with potentially large effects ongrowth and employment. Since the second half of 2011, the EBA arguedfor a three-pronged approach to address this situation:(i) Strengthening banks’ capital, to put them on a stronger footing tofinance the real economy and limit deleveraging;(ii) European interventions to support bank funding and break the linkwith the sovereigns; and(iii) Actions directly remedying the sovereign debt crisis, thus takingredenomination risk off the table.As supervisors, we tackled head on the first line of intervention, whichfalls directly in our remit. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 142. If we consider the capital injected in the system, for achieving thethreshold set in the 2011 stress test, and the adjustment in capitalpositions triggered by our Recommendation, which asked banks to setup a Core Tier 1 buffer equal to 9% of risk weighted assets, with aprudent valuation of sovereign exposures, the overall strengtheningalready realised is above € 190 bn – an amount very close to therecommendation issued by the IMF in the Autumn of 2011.The support measures already approved for Greek and Spanish bankswill bring the final figure further up, to a significant amount.We managed this complex process ensuring that banks did not achievethe capital target by cutting back on lending to households andcorporates, especially small and medium enterprises (SMEs).We also fostered close cooperation between home and host authoritieswithin supervisory colleges, to avoid that the possible capital adjustmentwas affected by a home bias.The EBA is committed to pursuing its efforts to ensure that the action ofbalance sheet repair continues.In this respect, supervisory coordination should take place to ensure thatbanks apply conservative and consistent valuation of assets and takeactions to gradually restore the smooth funding of their activities inprivate markets.The unlimited supply of term liquidity by the ECB and by otherEuropean central banks, and the decision to move towards a BankingUnion, which we strongly support, are other key components of thepolicy package to restore stability in the European banking sector.The Banking Union will have an impact on the responsibilities of theEBA as it will call on the whole Union for an even stronger commitmentto the Single Rulebook and for a leap towards truly unified supervisorymethodologies - a Single Supervisory Handbook - to assess the risks atbanks and to trigger corrective actions. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 143. Without such an effort, we risk a polarisation of the Single Marketbetween the euro area, with single rules and supervisory practices, andthe rest of the Union, which would operate with a still wide degree ofnational discretion in implementing and applying the Single Rulebook.The EBA has put a lot of effort in contributing to the action of regulatoryrepair and the establishment of the Single Rulebook, by preparing draftstandards in a number of areas defined by the proposed CRD4-CRR.At the request of the Commission, we also finalised a report on thecapital requirements for SME lending, a topic that is receiving greatattention also in your discussions.I believe we established a good working method, with open channels ofcommunication with this Committee and due process of openconsultation and impact assessment.This should allow us to promptly finalise our draft standards once thelegislative texts are approved.In the final stage of the negotiations, it is essential that all policy makersmaintain a strong commitment to rigorous and consistent rules, in linewith international standards.In the EU, these rules will be applied to all banks and should thereforeacknowledge the variety of business models and cultures.Proportionality will be a key concept in this respect.But in a large number of areas, it is essential that the yardsticks to assessthe solvency and liquidity of banks are effectively the same for all banksin the Single Market.The strong pressure we faced to address the difficult situation inbanking markets and in contributing to the reform of banking rulesdetermined a slower start in the accomplishment of our tasks in the areaof consumer protection. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 144. I am aware that the Parliament attaches great importance to these tasks.The urgency of making progress in this area is confirmed by the recentepisodes of mis-selling, poor compliance with anti-money launderingrules and manipulation of market benchmarks.We are now working at a much higher speed in these areas and envisageissuing important guidelines in the area of mortgage lending - onresponsible lending and on arrears management.Reviews of the risks for consumers and banks from financial innovationssuch as Exchange Traded Funds, Contacts for Differences andstructured products are also being finalised.Further work is taking place under the aegis of the Joint Committee.In conclusion, let me touch on the delicate issue of resources.We really appreciate the efforts made by the Parliament to strengthenour resources.Notwithstanding the generous support provided by national supervisoryauthorities, which have seconded a significant number of staff at ourpremises during the periods of our most intense workload, it remainsdifficult for us to fulfil our tasks under such stringent resourceconstraints.While the amount of staff envisaged in the steady state situation, to bereached around 2015, is still commensurate to our tasks, there is anurgent need to accelerate the process, as the difficult challenges we arefacing require that the resources are available as soon as possible.Thank you for your attention. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 145. EIOPA and FINMASign a Memorandum ofUnderstandingThe European Insurance and Occupational Pensions Authority(EIOPA) and the Swiss Financial Market Supervisory Authority(FINMA) have signed a Memorandum of Understanding (MoU) in Berntoday.The main objective of the MoU is to ensure optimal cooperation insupervision, in particular for insurance groups with internationalactivities in the European economic area (EEA) and Switzerland.The Memorandum creates a formal basis for cooperation in thefollowing areas: group supervision, assistance in the work of EEA andFINMAcolleges of supervisors, action required in emergency situations,safeguarding financial stability by monitoring and assessing risks,interconnectedness and conducting stress tests.The Authorities would like to emphasise that the Memorandum will notmodify or supersede any laws or regulatory requirements in force andwill not affect any arrangements under the MoUs that have previouslybeen signed between FINMA and other national supervisory authoritiesof the EEA.Anne Héritier Lachat, Chair of FINMA Board of Directors, said: “Inlight of the increased internationalisation of financial groups andfinancial products, international cooperation between supervisoryauthorities is gaining in importance.We are very interested in conducting an active and fruitful dialogue withkey financial regulators.The MoU with EIOPA provides us with a very good basis to do so”. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 146. Gabriel Bernardino, Chairman of EIOPA, said: “This is the firstMemorandum of Understanding ever signed by EIOPA. We arecommitted to pursue a constructive dialogue, effective cooperation andinformation exchange with FINMA.This MoU is an important step to reinforce the efficiency of supervisionand to enhance consumer protection in an increasingly global insurancemarket”.Note:European Economic Area (EAA) consists of 27 EU Member Statesincluding Iceland, Liechtenstein and Norway.The Swiss Financial Market Supervisory Authority (FINMA) is anindependent state supervisory authority of banks, insurance companies,exchanges, securities dealers, collective investment schemes,distributors and insurance intermediaries.The European Insurance and Occupational Pensions Authority(EIOPA) was established as a result of the reforms to the structure ofsupervision of the financial sector in the European Union.The reform was initiated by the European Commission, following therecommendations of a Committee of Wise Men, chaired by Mr deLarosière, and supported by the European Council and Parliament.EIOPA is part of the European System of Financial Supervisionconsisting of three European Supervisory Authorities, the NationalSupervisory Authorities and the European Systemic Risk Board.It is an independent advisory body to the European Commission, theEuropean Parliament and the Council of the European Union.EIOPA’s core responsibilities are to support the stability of the financialsystem, enhance the transparency of markets and financial products, and _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 147. protect insurance policy holders, pension scheme members andbeneficiaries.Memorandum of Understanding (MoU) between the EuropeanInsurance and Occupational Pensions Authority (EIOPA) andthe Swiss Financial Market Supervisory Authority (FINMA)(hereinafter referred to as “Authorities”)whereas,EIOPA is, under Regulation (EU) No. 1094/2010 of the EuropeanParliament and of the Council of 24 November 2010 establishing theEuropean Insurance and Occupational Pensions Authority (“TheRegulation”), expected to ensure the orderly functioning and integrity offinancial markets and the stability of the financial system in theEuropean Union.With regard to EIOPA’s role under this MoU, Articles 8 (f) and (i), 17, 18,21, 23, 33, 35 and 70 of The Regulation are particularly relevant.EIOPA has under The Regulation the task to pursue a constructivedialogue and effective cooperation with supervisory authorities outsidethe European Union.EIOPA has also the task to contribute as a competent authority tocolleges of supervisors (“EEA Colleges”).EEA Colleges may also include third country subsidiaries and branchesor financial groups having their headquarters in third countries and theirsubsidiaries or branches in the European Union.EIOPA facilitates and updates the so called Helsinki plus list whichprovides information on EEA insurance groups and their supervision. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 148. EIOPA will in its contacts with FINMA fully respect the existing rolesand respective competences of the EU Member States, Liechtenstein,Iceland, Norway and the European Union institutions.This arrangement will not create legal obligations in respect of theEuropean Union, its Member States, Liechtenstein, Iceland and Norwaynor shall it prevent Member States and Liechtenstein, Iceland andNorway and their competent authorities from concluding bilateral ormultilateral arrangements with FINMA.Since the tasks of EIOPA as a European Supervisory Authority are of aspecific nature, a separate MoU between EIOPA and FINMA is needed.FINMA has under the Federal Act on the Swiss Financial MarketSupervisory Authority (FINMASA) of 22 June 2007, notably Article 6 (2),the remit to fulfil the international tasks that are related to its supervisoryactivity.FINMA may, in particular, according to Article 42 FINMASA, cooperatewith foreign authorities responsible for financial market supervisionincluding the sharing of confidential information and documents.FINMA sets up and chairs supervisory colleges (“FINMA Colleges”)pursuant to its Policy on Insurance Supervisory Colleges where FINMAis the responsible group supervisor of an insurance group withinternational activities. In this context, FINMA is to liaise with theforeign authorities responsible for the supervision of relevant groupentities.FINMA also participates where appropriate in insurance supervisorycolleges organised by foreign supervisory authorities.A. Principles and Scope1. The purpose of this Memorandum of Understanding (MoU) is toestablish a formal basis for cooperation with a view to furtherstrengthening the dialogue and cooperation between EIOPA and _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 149. FINMA within their respective statutory remits pertaining to insuranceregulation and supervision, and more in particular regarding:• The exchange of information and assistance relating to insurancegroups under group supervision of FINMA or of a supervisory authorityconsidered a Voting Member or Observer in EIOPA’s Board ofSupervisors and have business activities in the respective jurisdiction ofthe other authority, in particular exchange of information and assistancerelating to the work of EEA and FINMA Colleges, and action requiredin emergency situations.• The exchange of information for macroprudential (financial stability)purposes, such as monitoring and assessment of risks,interconnectedness, and stress testing.2. This MoU does not modify or supersede any laws or regulatoryrequirements in force with regard to, or applying to, FINMA or in forcewith regard to, or applying to, EIOPA.This MoU sets forth a statement of intent and accordingly does notcreate any enforceable rights.This MoU does not affect any arrangements under other MoUs.3. The Authorities acknowledge that they may only provide informationunder this MoU if permitted or not prevented under applicable laws,regulations and requirements.4. For EIOPA, all confidential information exchanged under this MoUwill be subject to EIOPA’s obligation of professional secrecy (Article 70of The Regulation and EIOPA’s confidentiality policy).5. For FINMA, all confidential information exchanged under this MoUwill be subject to FINMA’s obligation of professional secrecy (Article 14FINMASA). _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 150. B. Cooperation for Supervision of Insurance Groups andConglomerates6. The Authorities agree that the aim of cooperation is to ensure optimalsupervision in particular for insurance groups with internationalactivities in the EEA and Switzerland.The cooperation should be carried out efficiently and effectively, andshould not impose unnecessary burden for the insurance undertakingssubject to supervision, or for the Authorities involved.7. The Authorities will make all reasonable efforts to exercise thecooperation and coordination in a spirit of mutual trust.8. FINMA may participate in the activities of the EEA Colleges formedby the EEA Authorities when a Swiss insurance undertaking isconcerned. In this case EIOPA Guidelines on EEA Colleges shall apply.9. When Swiss based insurance groups with activities in the EEA aresubject to group supervision by FINMA, EIOPA may participate in theactivities of the FINMA colleges.In this case, the FINMA Policy on Insurance Supervisory Colleges shallapply.10. EIOPA will facilitate information exchange between FINMA and theSupervisory Authority considered a Voting Member or Observer inEIOPA’s Board of Supervisors, in particular by making the Helsinki pluslist3 accessible to FINMA.11. FINMA will provide information to complete the Helsinki plus list4to enable EIOPA to keep the list up to date.12. EIOPA will in its oversight function also use information receivedfrom FINMA to prepare for the EEA College work. Only in the cases ofArticles 17 and 18 of The Regulation, EIOPA may use such informationfor supervisory purposes. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 151. C. Macroprudential tasks13. FINMA and EIOPA will share relevant information to fulfil theirmacroprudential tasks.D. Procedure for Requests for Information and Assistance14. If a request for information and assistance is made, each Authoritywill make reasonable efforts to provide assistance to the other, subject toits laws and overall policy.15. Requests for the provision of information or assistance should bemade in writing.In urgent cases, requests may be made orally to the usual contactpersons, in summary form to be followed as soon as possible by a fullrequest.16. Requests for information and assistance should specify:a. the individual or aggregated information or assistance requested;b. a description of the matter which gives rise to the request;c. the purpose for which the information is sought (including details ofthe lawsand regulatory requirements pertaining to the matter which is thesubject of the request);d. the persons believed by the requesting Authority to possess theinformation sought, or the place where such information may beobtained, if known;e. to whom, if anyone, onward disclosure of information is likely to benecessary and the reason for such disclosure;f. the desired time period for the reply. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 152. Assessment of requests17. Each request for information and assistance should be assessed on acase-by-case basis by the recipient Authority to determine whetherassistance can be provided under the terms of this MoU.18. In any case where the request cannot be fulfilled in part or whole, therecipient Authority may consider whether there may be other assistancewhich can be given by itself or by any other organisation in itsjurisdiction.19. In deciding whether and to what extent to fulfil a request, therecipient Authority may take into account:a. whether the request conforms with this MoU;b. whether the request involves the administration of a law, regulation orrequirement which has no close parallel in the jurisdiction of therequested Authority;c. whether the provision of assistance would be so burdensome as todisrupt the proper performance of the recipient Authority’s functions;d. whether it would be otherwise contrary to the public interest or theessential national interest of the recipient Authority’s jurisdiction to givethe assistance sought;e. any other matters specified by the laws, regulations and requirementsof the recipient Authority’s jurisdiction (in particular those relating toconfidentiality and professional secrecy, data protection and privacy, andprocedural fairness); andf. whether complying with the request may otherwise be prejudicial tothe performance by the recipient Authority of its functions.g. whether the request would lead to the prosecution or taking ofdisciplinary action or other enforcement action against a person who inthe opinion of the requested Authority has already been appropriately _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 153. dealt with in relation to the alleged breach in the subject matter of therequest.20. The Authorities recognise that assistance may be denied in whole orin part for any of the above reasons in the discretion of the recipientAuthority.Contact Points21. The Authorities will provide a list of contact points (departments orteams in the organisation) to which information or requests forinformation and/or assistance under this MoU should be directed.Costs22. If the cost of fulfilling a request is likely to be substantial, therecipient Authority may, as a condition of agreeing to give assistanceunder this MoU, require the requesting Authority to make a contributionto any costs incurred.E. Permissible Use and Confidentiality23. If the Authorities receive confidential information under this MoU,they agree to treat such information as confidential in accordance withthe provisions of this MoU.24. An Authority that receives confidential information under this MoUmay use that information for the purposes set forth in the request forinformation and/or assistance.25. If the recipient Authority intends to use information provided underthis MoU for any purposes other than those contemplated in paragraph24, it will seek prior consent of the Authority providing the information.26. The requesting Authority confirms that it will seek consent from therequested Authority before disclosing any confidential information itreceives under this MoU. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 154. 27. Before disclosing the information obtained pursuant to this MoU tothird parties, the requesting Authority will seek a commitment fromthem to keep the information confidential.28. The recipient Authority will undertake every effort to comply withany restrictions on the use or disclosure of information that are agreedwhen the information is provided.29. If the requesting Authority is subject to a mandatory disclosurerequirement or receives a legally enforceable demand for informationunder applicable laws, regulations and requirements, the requestingAuthority will notify the requested Authority of its obligation to discloseand will endeavour to seek consent from the requested Authority beforemaking a disclosure. If the requested Authority withholds its consent,the requesting Authority will make its best efforts to protect theconfidentiality of confidential information obtained according to itsconfidentiality obligations stated under paragraphs 4 and 5 and, ifnecessary, to resist disclosure, including asserting such appropriate legalexemptions or privileges with respect to that information as may beavailable, for example by advising the concerned court or requestingparty of the possible negative consequences of a disclosure on futureco8operation between the Authorities.30. The Authorities agree to treat the confidential information receivedunder this MoU as confidential to the extent permitted by law even afterwithdrawal from this MoU under paragraph 32 below.F. Consultation31. The Authorities will keep the operation of this MoU under review andwill consult when necessary:a. in the event of a dispute over the meaning of any term used in theMoU; _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 155. b. in the event of a substantial change in the laws, regulations orpractices affecting the operation of the MoU;c. in the event of any Authority proposing to withdraw from the MoU;andd. whenever necessary, with a view to improving its operation andresolving any matters.G. Commencement, Withdrawal and Amendment32. This MoU will take effect when signed. Any Authority may withdrawfrom the MoU by giving 30 days advance written notice to the otherAuthority.The MoU may be amended by agreement in writing. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 156. Joint Forum, Principles for thesupervision of financial conglomeratesCorporate GovernanceBroadly, corporate governance describes theprocesses, policies and laws that govern how acompany or group is directed, administered orcontrolled.It defines the set of relationships between acompany’s management, its board, itsshareholders, and other recognisedstakeholders.Corporate governance also provides the structure through which theobjectives of the company are set, and the means of attaining thoseobjectives and monitoring performance are determined.Good corporate governance should provide proper incentives for theboard and management to pursue objectives that are in the interests ofthe company and its shareholders and should facilitate effectivemonitoring.The presence of an effective corporate governance system, within anindividual company or group and across an economy as a whole, helps toprovide a degree of confidence that is necessary for the properfunctioning of a market economy.Financial conglomerates are often complex groups with multipleregulated and unregulated financial and other entities.Given this inherent complexity, corporate governance must carefullyconsider and balance the combination of interests of recognisedstakeholders of the ultimate parent, and the regulated financial and otherentities of the group. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 157. Ensuring that a common strategy supports the desired balance and thatregulated entities are compliant with regulation on an individual and onan aggregate basis should be a goal of the governance system.This governance system is the fiduciary responsibility of the board ofdirectors.When assessing corporate governance across a financial conglomerate,supervisors should apply these principles in a manner that is appropriateto the relevant sectors and the supervisory objectives of those sectors.This section describes the elements of the governance system mostrelevant to financial conglomerates, and how they should be assessed bysupervisors.Corporate governance in financial conglomerates10. Supervisors should seek to ensure that the financial conglomerateestablishes a comprehensive and consistent governance frameworkacross the group that addresses the sound governance of the financialconglomerate, including unregulated entities, without prejudice to thegovernance of individual entities in the group.Implementation criteria10(a) Supervisors should require that the corporate governanceframework of the financial conglomerate has minimum requirements forgood governance of the entities of the financial conglomerate whichallow for the prudential and legal obligations of its constituent entities tobe effectively met.The ultimate responsibility for the sound and prudent management of afinancial conglomerate rests with the board of the head of the financialconglomerate. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 158. 10(b) Supervisors should require that the financial conglomerateemphasises a high degree of integrity in the conduct of its affairs.10(c) Supervisors should seek to ensure that the corporate governanceframework appropriately balances the diverging interests of constituententities and the financial conglomerate as a whole.10(d) Supervisors should require that the governance framework respectsthe interests of policy holders and depositors (where relevant), andshould seek to ensure that it respects the interests of other recognisedstakeholders of the financial conglomerate and the financial soundnessof entities in the financial conglomerate.10(e) Supervisors should require that the governance framework includesadequate policies and processes that enable potential intra-groupconflicts of interest to be avoided, and actual conflicts of interest to beidentified and managed.Explanatory comments10.1 The corporate governance framework should address whereappropriate:• Alignment to the structure of the financial conglomerate;• Financial soundness of the significant owners;• Suitability of board members, senior management and key persons incontrol functions including their ability to make reasonable andimpartial business judgments;• Fiduciary responsibilities of the boards of directors and seniormanagement of the head company and material subsidiaries;• Management of conflicts of interest, in particular at the intra-grouplevel and remuneration policies and practices within the financialconglomerate; and _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 159. • Internal control and risk management systems and internal audit andcompliance functions for the financial conglomerate.10.2 The group’s corporate governance framework should notablyinclude a strong risk management framework (refer to the RiskManagement section), a robust internal control system, effective internalaudit and compliance functions, and ensure that the group conducts itsaffairs with appropriate independence and a high degree of integrity.10.3 Group-wide governance not only involves the governance of thehead of the financial conglomerate, but also applies group-wide to allmaterial activities and entities of the financial conglomerate.10.4 In the event the local corporate governance requirements applicableto any particular material entity in the financial conglomerate are belowthe group standards, the more stringent group corporate governancestandards should apply, except where this would lead to a violation oflocal law.10.5 Supervisors should require that the corporate governance frameworkof the financial conglomerate includes a code of ethical conduct.10.6 Supervisors should require that the financial conglomerate have inplace policies focused on identifying and managing potential intra-groupconflicts of interest, including those that may result from intra-grouptransactions, charges, up streaming dividends, and risk-shifting.The policies should be approved by the board of the head of the financialconglomerate and be effectively implemented throughout the group.The policies should recognise the long-term interest of the financialconglomerate as a whole, the long term interest of the significant entitiesof the financial conglomerate, the stakeholders within the financialconglomerate, and all applicable laws and regulations. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 160. Structure of the financial conglomerate11. Supervisors should seek to ensure that the financial conglomerate hasa transparent organisational and managerial structure, which isconsistent with its overall strategy and risk profile and is well understoodby the board and senior management of the head company.Implementation criteria11(a) Supervisors should understand the financial conglomerate’s groupstructure and the impact of any proposed changes to this structure.11(b) Supervisors should assess the ownership structure of the financialconglomerate, including the financial soundness and integrity of itssignificant owners.11(c) Supervisors should seek to ensure that the structure of the financialconglomerate does not impede effective supervision. Supervisors mayseek restructuring under appropriate circumstances to achieve this, ifnecessary.11(d) Supervisors should seek to ensure that the board and seniormanagement of the head of the financial conglomerate are capable ofdescribing and understanding the purpose, structure, strategy, materialoperations, and material risks of the financial conglomerate, includingthose of unregulated entities that are part of the financial conglomeratestructure.11(e) Supervisors should assess and monitor the financial conglomeratesprocess for approving and controlling structural changes, including thecreation of new legal entities.11(f) Where the financial conglomerate is part of a wider group,supervisors should require that the board and senior management of thehead of the financial conglomerate have governance arrangements thatenable material risks stemming from the wider group structure to beidentified and appropriately assessed by relevant supervisory authorities. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 161. 11(g) Supervisors should seek to ensure that there is a frameworkgoverning information flows within the financial conglomerate andbetween the financial conglomerate and entities of the wider group (egreporting procedures).Explanatory comments11.1 A financial conglomerate may freely set its functional, hierarchical,business and/or regional organisation, provided all entities within thefinancial conglomerate comply with their relevant sectoral and legalframeworks.11.2 Elements to be considered for assessing the significant ownershipstructure of the financial conglomerate may include the identification ofsignificant owners, including the ultimate beneficial owners, thetransparency of their ownership structure, their financial information,and the sources of their initial capital and all other requirements ofnational authorities.At a minimum, the necessary qualities of significant owners relate to theintegrity demonstrated in personal behaviour and business conduct, aswell as to the ability to provide additional support when needed.11.3 Supervisors should seek to ensure that a financial conglomerate hasan organisational and managerial structure that promotes and enablesprudent management, and if necessary, orderly resolution aligned withcorresponding sectoral requirements.Reporting lines within the financial conglomerate should be clear andshould facilitate information flows within the financial conglomerate,both bottom-up and top-down.11.4 Supervisors should be satisfied that the board and seniormanagement of the head of the financial conglomerate understand andinfluence the evolution of an appropriate group legal structure inalignment with the approved business strategy and risk profile of the _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 162. financial conglomerate, and understand how the various elements of thestructure relate to one another.Where a financial conglomerate creates many legal entities, their numberand, particularly, the interconnections and transactions between them,may pose challenges for the design of effective corporate governancearrangements.This risk should be recognised and managed.This is particularly the case where the organisational and managerialstructure of the financial conglomerate deviates from the legal entitystructure of the financial conglomerate.11.5 Supervisors should assess changes to the group structure and howthese changes impact its soundness, especially where such changescause the financial conglomerate to engage in activities and/or operatein jurisdictions that impede transparency or do not meet internationalstandards stemming from sectoral regulation.Suitability of board members, senior managers and key personsin control functions12. Supervisors should seek to ensure that the board members, seniormanagers and key persons in control functions in the various entities in afinancial conglomerate possess integrity, competence, experience andqualifications to fulfil their role and exercise sound objective judgment.Implementation criteria12(a) Supervisors should be satisfied of the suitability of board members,senior managers and key persons in control functions.12(b) Supervisors should require financial conglomerates to havesatisfactory processes for periodically assessing suitability. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 163. 12(c) Supervisors should require that the members of the boards of thehead of the financial conglomerate and of its significant subsidiaries actindependently of parties and interests external to the wider group; andthat the board of the head of the financial conglomerate include anumber of members acting independently of the wider group (includingowners, board members, executives, and staff of the wider group).12(d) Supervisors should communicate with the supervisors of otherregulated entities within the conglomerate when board members, seniormanagement and key persons in control functions are deemed not tomeet their suitability tests.Explanatory comments12.1 Board members, senior managers and key persons in controlfunctions need to have appropriate skills, experience and knowledge,and act with care, honesty and integrity, in order to to make reasonableand impartial business judgments and strengthen the protectionafforded to recognised stakeholders.To this end, institutions need to prudently manage the risk that personsin positions of responsibility may not be suitable.Suitability criteria may vary depending on the degree of influence on orthe responsibilities for the financial conglomerate.12.2 Supervisors of regulated entities of the financial conglomerate aresubject to statutory and other requirements in applying suitability teststo these entities in their jurisdiction.The organisational and managerial structure of financial conglomeratesadds elements of complexity for supervisors seeking to ensure thesuitability of persons. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 164. For instance, the management of regulated entities within the financialconglomerate can be extensively influenced by persons who are notdirectly responsible for such functions.A group-wide perspective regarding suitability of persons is intended toclose any loopholes in this respect.Supervisors may rely on assessments made by other relevant supervisorsin this area regarding suitability.Alternatively they may decide on concerted supervisory actionsregarding suitability if required.12.3 In order to meet suitability requirements, board members, seniormanagers and key persons in control functions, both individually andcollectively, should have and demonstrate the ability to perform theduties or to carry out the responsibilities required in their position.Competence can generally be judged from the level of professionalism(eg pertinent experience within financial industries or other businesses)and/or formal qualifications.12.4 Serving as a board member or senior manager of a company (fromthe wider group) that competes or does business with the regulatedentities in the financial conglomerate can compromise independentjudgment and create conflicts of interest, as can cross-membership onboards.A board’s ability to exercise objective judgment independent of the viewsof executives and of inappropriate political or personal interests can beenhanced by recruiting members from a sufficiently broad population ofcandidates.The key characteristic of independence is the ability to exerciseobjective, independent judgment after fair consideration of all relevantinformation and views without undue influence from executives or from _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 165. inappropriate external parties and interests and while taking intoaccount the requirements of applicable law.Responsibility of the board of the head of the financialconglomerate13. Supervisors should require that the board of the head of the financialconglomerate appropriately defines the strategy and risk appetite of thefinancial conglomerate, and ensures this strategy is implemented andexecuted in the various entities, both regulated and unregulated.Implementation criteria13(a) Supervisors should require that the board of the head of thefinancial conglomerate has in place a framework for monitoringcompliance with the strategy and risk appetite across the financialconglomerate.13(b) Supervisors should require that the board of the head of thefinancial conglomerate regularly assesses the strategy and risk appetiteof the financial conglomerate to ensure it remains appropriate as theconglomerate evolved.13(c) Where the financial conglomerate is part of a wider group,supervisors should assess whether the head is managing its relationshipwith the wider group and ultimate parent in a manner that is consistentwith the governance framework of the financial conglomerate.13(d) Supervisors should require that a framework is in place whichseeks to ensure resources are available across the financial conglomeratefor constituent entities to meet both the group and their own entity’sgovernance standards. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 166. Explanatory comments13.1 Supervisors should assess if the board of directors exercisesadequate oversight over the management of the head of the financialconglomerate.This includes assessing the actions taken by the board of the head todefine the strategy for the financial conglomerate and ensure theconsistency of the operations of the various entities in the financialconglomerate with such strategy.To this end, the head company should set up an adequate corporategovernance framework in line with the structure, business and risks ofthe financial conglomerate and its entities and applicable laws.This framework should ensure that the strategy is implemented andmonitored throughout the financial conglomerate and reviewed on aregular basis and following material change including due to growth,increased complexity, geographic expansion, etc.13.2 The head company should exercise adequate oversight ofsubsidiaries, both regulated and unregulated, while respectingindependent legal and governance responsibilities.Supervisors should satisfy themselves that entities within a financialconglomerate adhere to the same group-wide corporate governanceprinciples or at least apply policies that remain consistent with theseprinciples.The board of a regulated subsidiary of a financial conglomerate willretain and set its own corporate governance responsibilities andpractices in line with its own legal requirements or in proportion to itssize or business.These should not, however, conflict with the broader financialconglomerate corporate governance framework. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 167. Appropriate governance arrangements will address arrangements suchthat legal or regulatory provisions or prudential rules of regulatedsubsidiaries will be known and taken into account by the head company.13.3 Where the financial conglomerate is part of a wider group structure,the head of the financial conglomerate is responsible for managing therelationship with its wider group.This includes ensuring there are appropriate arrangements for capitaland liquidity management, assessing any material risk impact that maycome from decisions made at its ownership level, service levelagreements, reporting lines and regular top-level consultations withrelated companies in the wider group and the ultimate parent.13.4 For smaller institutions within a larger conglomerate, it may beunnecessary to duplicate systems and controls.Such smaller institutions can rely on the systems and controls of thehead if they have assessed that this is suitable to address group risks.13.5 Supervisors should be satisfied with the amount and quality ofinformation they receive from the head company of the financialconglomerate on its strategy, risk appetite and corporate governanceframework.Remuneration in a financial conglomerate14. Supervisors should require that the financial conglomerate has andimplements an appropriate remuneration policy that is consistent withits risk profile. The policy should take into account the material risksthat organisation is exposed to, including those from its employees’activities.Implementation criteria14(a) Supervisors should require that an appropriate remuneration policyconsistent with established international standards is in place and _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 168. observed at all levels and across jurisdictions in the financialconglomerate.An appropriate policy aligns risk-takers’ variable remuneration withprudent risk taking, promotes sound and effective risk management, andtakes into account any other appropriate factors.The overarching objective of the policy should be consistent across thegroup but can allow for reasonable differences based on the nature of theconstituent entities/units and local legal requirements.14 (b) Supervisors should require that ultimate oversight of theremuneration policy rest with the financial conglomerate’s headcompany.14(c) Supervisors should require that the remuneration of boardmembers, senior managers and key persons in control functions bedetermined in a manner that does not incentivise them to disregard theobligations they owe to the financial conglomerate or any of its entities,nor to otherwise act in a manner contrary to any legal or regulatoryobligations.14(d) Supervisors should require that the risks associated withremuneration are reflected in the financial conglomerate’s broader riskmanagement framework.For example, staff engaged in financial and risk control at the group-wide level should be compensated in a manner that is consistent withtheir control role and should be involved in designing incentivearrangements, and assessing whether such arrangements encourageimprudent risk-taking.14(e) Supervisors should require that the variable remuneration receivedby risk management and control personnel is not based substantially onthe financial performance of the business units that they review butrather on the achievement of the objectives of their functions (egadherence to internal controls). _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 169. Explanatory comments14.1 Remuneration is a key aspect of any governance framework andneeds to be properly considered in order to mitigate the risks that mayarise from poorly designed remuneration arrangements.The risks associated with remuneration should be reflected in thefinancial conglomerate’s broader risk management framework.14.2 Remuneration may serve important objectives, including attractingskilled staff, promoting better organisation-wide and employeeperformance, promoting retention, providing retirement security andallowing personnel costs to vary with revenues.It is also clear, however, that ill-designed compensation arrangementscan provide incentives to take risks that are not consistent with the longterm health of the organisation. Such risks and misaligned incentives areof particular supervisory interest.14.3 Ultimately a financial conglomerate’s remuneration policy shouldaim to ensure effective governance of remuneration, alignment ofremuneration with prudent risk-taking, and engagement of recognisedstakeholders.14.4 Supervisors should ensure that the governance system identifies andcloses loopholes that allow the circumvention of conglomerate, sectoralor entity-level remuneration requirements.14.5 Board members, senior managers and key persons in controlfunctions should be measured against performance criteria tied not onlyto the short-term, but also to the long-term interest of the financialconglomerate as a whole. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 170. V. Risk ManagementSince financial conglomerates are in the business of risk-taking, goodrisk management is a crucial focus of supervision.This section provides principles for the sound and comprehensivesupervision of risk management frameworks in financial conglomerates.It covers factors ranging from risk culture and tolerance, to the use ofstress and scenario testing and the monitoring of risk concentrations.Risk management framework21. Supervisors should require that an independent, comprehensive andeffective risk management framework, accompanied by a robust systemof internal controls, effective internal audit and compliance functions, isin place for the financial conglomerate.Implementation criteria21(a) Supervisors should ensure that the risk management framework iscomprehensive, consistent across entities supervised in all sectors andcovers the risk management function, risk management processes andgovernance, and systems and controls.Risk management function21(b) Supervisors should require that the risk management function isindependent from the business units and has a sufficient level ofauthority and adequately skilled resources to carry out its functions.21(c) Supervisors should require that the risk management functiongenerally has a direct reporting line to the board and senior managementof the financial conglomerate.21(d) Supervisors should, where they consider it appropriate, require thata separate risk management committee at the board of directors level is _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 171. established by the financial conglomerate.Risk management governance21(e) Supervisors should require that the board of the head of thefinancial conglomerate has overall responsibility for the financialconglomerate’s group-wide risk management, internal controlmechanism, internal audit and compliance functions to ensure that thegroup conducts its affairs with a high degree of integrity.21(f) Supervisors should require that the financial conglomerate has anestablished enterprise-wide risk management process for, among others,periodically reviewing the effectiveness of the group-wide riskmanagement framework and for ensuring appropriate aggregation ofrisks.21(g) Supervisors should require that the risk management process coveridentification, measurement, monitoring and controlling of risk types (egcredit risk, operational risk, strategic risk, liquidity risk) and these belinked where appropriate to specific capital requirements.Systems and controls21(h) Supervisors should require that financial conglomerates have inplace adequate, sound and effective risk management processes andinternal control mechanisms at the level of the financial conglomerate,including sound administrative and accounting procedures.21(i) Supervisors should require that risk management processes andinternal control mechanisms of a financial conglomerate areappropriately documented and, at a minimum, take into account the:• nature, scale and complexity of its business;• diversity of its operations, including geographical reach ; _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 172. • volume, frequency and size of its transactions;• degree of risk associated with each area of its operation;• interconnectedness of the entities within the financial conglomerate(using intra-group transactions and exposures reporting as onemeasure); and• sophistication and functionality of information and reporting systems.Explanatory comments21.1 Financial conglomerates, irrespective of their particular mix ofbusiness lines or financial sectors, are in the business of risk taking.Therefore, strong risk management is of paramount importance.21.2 The comprehensive risk management framework and processshould include board and senior management oversight.21.3 In identifying, evaluating, monitoring, controlling and mitigatingmaterial risks (from regulated and unregulated activities), financialconglomerates should consider the prospect for these to change overtime and prepare themselves accordingly.21.4 The risk management processes and internal control mechanisms ofa financial conglomerate should include clear arrangements fordelegating authority and responsibility; segregation of the functions thatinvolve committing the financial conglomerate’s funds and accountingfor assets and liabilities; reconciliation of these processes; safeguardingof the financial conglomerate’s assets; and appropriate independentinternal audit and compliance functions to test adherence to thesecontrols as well as applicable laws and regulations.Risk tolerance levels and risk appetite policy23. Supervisors should require that the financial conglomerate _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 173. establishes appropriate board approved, group-wide risk tolerance levelsand a risk appetite policy.Implementation criteria23(a) Supervisors should require that key staff, senior management andthe board of the head of the financial conglomerate be aware of andunderstand the financial conglomerate’s risk tolerance levels and riskappetite policy.23(b) Supervisors should require that the financial conglomerate identifyand measure against risk tolerance limits (and in line with its riskappetite policy) the risk exposure of the financial conglomerate on anon-going basis in order to identify potential risks as early as possible.This may include looking at risks by territory, by line of business, or byfinancial sector.Explanatory comments23.1 Financial conglomerates should establish risk tolerance levels and arisk appetite policy which set the tone for acceptable and unacceptablerisk taking.This should be aligned with the financial conglomerate’s businessstrategy, risk profile and capital plan.23.2 A financial conglomerate’s risk tolerance should be kept underperiodic review so as to ensure that it remains relevant and takes accountof the changing dynamics of the financial conglomerate.The financial conglomerate’s risk appetite policy is re-assessed regularlywith respect to new business opportunities, changes in risk capacity andtolerance, and operating environment. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 174. New business24. Supervisors should require that the financial conglomerate carries outa robust risk assessment when entering into new business areas.Implementation criteria24(a) Supervisors should, where they consider it appropriate, review therisk assessment carried out by a financial conglomerate in the context ofentering into new business.24(b) Supervisors should require that financial conglomerates notexpand into new products unless they have put in place adequateprocesses, controls and systems (such as IT) to manage them.24(c) Supervisors should make sure that a financial conglomerate carriesout the ongoing risk assessment after entering into new business areas.Explanatory comments24.1 At the time of assessing whether or not to enter into a new businessarea or product line, it is imperative that financial conglomeratesundertake risk assessments and analyses to identify potential risksinherent in the new activity.24.2 They should seek to understand the potential interaction betweenthe risks of the new activity and the existing risk profile of the financialconglomerate.This should include a consideration of whether the new activity couldadversely affect the risk appetite or risk tolerance of the financialconglomerate. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 175. Outsourcing25. Supervisors should require that, when considering whether tooutsource a particular function, the financial conglomerate carries out anassessment of the risks of outsourcing, including the appropriateness ofoutsourcing a particular function.Implementation criteria25(a) Supervisors should require that financial conglomerates haveprocesses and criteria in place to review decisions to outsource afunction in order to ensure that such outsourcing does not implydelegation of responsibility for that function.25(b) Supervisors should be satisfied that the decision to outsource afunction does not impede effective group-wide supervision of thefinancial conglomerate.Explanatory comments25.1 It is important that supervisors be satisfied that, when consideringwhether to outsource a particular function, financial conglomerates haveconsidered the risks involved and the appropriateness of outsourcing aparticular function.This includes considering the appropriateness of outsourcing to aparticular provider and the cumulative risks of all outsourced functions.The supervisor should require the financial conglomerate to review theprovider in advance to ensure it is in a position to provide the services,comply with the contractual terms, and observe all applicable laws andregulations.25.2 Supervisors should periodically assess the outsourced function withregard to policy compliance, risk management measures and controlprocedures. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 176. 25.3 Outsourcing should never result in a delegation of responsibility fora given function.There may be certain functions within financial conglomerates whichshould not be outsourced under any circumstances, while there may besome that may only be outsourced if certain safeguards are put in place.Stress and scenario testing26. Supervisors should require, where appropriate, that the financialconglomerate periodically carries out group-wide stress tests andscenario analyses for its major sources of risk.Implementation criteria26(a) Supervisors should require that stress tests are sufficiently severe,forward looking and flexible.They should cover an appropriate set of business activities and include avariety of different types of tests such as sensitivity analyses, scenarioanalyses and reverse stress testing.26(b) Supervisors should require the financial conglomerate to documentits stress and scenario tests, including reverse stress tests.Stress tests should be conducted under a robust governance frameworkthat encompasses policies, procedures, and adequate documentation ofprocedures as well as validation of results.26(c) Supervisors should require that the group-wide stress tests andscenario analyses conducted by the financial conglomerate areappropriate to the nature, scale and complexity of those major sources ofrisk and to the nature, scale and complexity of the financialconglomerate’s business. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 177. 26(d) Supervisors should require that group-wide stress tests andscenario analyses include a group-wide approach (which takes accountof the interaction between different parts of the group and different risktypes) and consider the results of sectoral stress tests.26(e) Supervisors should require that, when carrying out reverse stresstests, a financial conglomerate identifies a range of adversecircumstances which would cause its business to fail and assess thelikelihood of such events crystallising.Explanatory comments26.1 A financial conglomerate should have a good understanding ofcorrelation between its respective sectors and the heterogeneity of suchrisks when conducting its stress tests.Stress tests should be robust and should consider sufficiently adversecircumstances.The group-wide stress test analysis should measure and evaluate thepotential impact on individual entities.26.2 Attention should be paid to covering all risks, including off-balancesheet items.For example, a financial conglomerate’s stress tests and scenarioanalyses should take into account the risk that the financialconglomerate may have to bring back on to its consolidated balancesheet the assets and liabilities of off-balance sheet entities as a result ofreputational contagion, notwithstanding the appearance of legal risktransfer.26.3 Where reverse stress tests reveal a risk of business failure that isunacceptably high relative to the financial conglomerate’s risk appetiteor risk tolerance, the financial conglomerate should evaluate and adopt, _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 178. where appropriate, effective arrangements, processes, systems or othermeasures to prevent or mitigate that risk.Risk aggregation27. Supervisors should require that the financial conglomerate aggregatethe risks to which it is exposed in a prudent manner.Implementation criteria27(a) Supervisors should require that financial conglomerates ***notmake overly ambitious diversification assumptions*** or imprudentcorrelation claims, particularly for capital adequacy and solvencypurposes.27(b) Supervisors should require financial conglomerates to haveadequate resources and systems (including IT) for the purpose ofaggregating risks.Explanatory comments27.1 Risk aggregation should include a clear understanding ofassumptions and be robust enough to support a comprehensiveassessment of risk.27.2 While it is possible that the spread of activities within a financialconglomerate may create diversification effects and reduce correlation, itis also true that membership of a financial conglomerate group maycreate “group risks” in the form of financial contagion, reputationalcontagion, ratings contagion (where a subsidiary accesses capitalthrough a parent’s credit rating and then suffers stress following theutilisation of the capital), double/multiple-gearing (use of same capitalmore than once within a group), excessive leveraging (upgrade in thequality of capital as it moves through a group), and regulatory arbitrage(it is important that risks are assessed at the financial conglomerate levelas well as at the level of its constituent parts). _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 179. Risk concentrations and intra-group transactions andexposures28. Supervisors should require that the financial conglomerate has inplace effective systems and processes to manage and report group-widerisk concentrations and intra-group transactions and exposures.Implementation criteria28(a) Supervisors should require that the financial conglomerate has inplace effective systems and processes to identify, assess and reportgroup-wide risk concentrations (including for the purposes ofmonitoring and controlling those concentrations).28(b) Supervisors should require that the financial conglomerate has inplace effective systems and processes to identify, assess and reportsignificant intra-group transactions and exposures.28(c) Supervisors should require the financial conglomerate to reportsignificant risk concentrations and intra-group transactions andexposures at the level of the financial conglomerate on a regular basis.28(d) Supervisors should consider setting quantitative limits andadequate reporting requirements.Explanatory comments28.1 Supervisors should ensure that financial conglomerates aremanaging their risk concentrations and intra-group transactions andexposures satisfactorily.28.2 Supervisors should encourage adequate public disclosure of riskconcentrations and intra-group transactions and exposures.28.3 Supervisors should liaise closely with one another to ascertain eachother’s concerns and coordinate as deemed appropriate any supervisory _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 180. action relative to risk concentrations and intra-group transactions andexposures within the financial conglomerate.28.4 Supervisors should deal effectively with material risk concentrationsand intra-group transactions and exposures that are considered to have adetrimental effect on the regulated entities or the financial conglomerateas a whole.Off-balance sheet activities29. Supervisors should require that off-balance sheet activities, includingspecial purpose entities, are brought within the scope of group-widesupervision of the financial conglomerate, where appropriate.Implementation criteria29(a) Supervisors should require that there is a process for determiningwhether the nature of the relationship between the financialconglomerate and a special purpose entity (SPE) requires the SPE to befully or proportionally consolidated into the financial conglomerate forregulatory purposes.29(b) Supervisors should require that the financial conglomerate’s stresstests and scenario analyses take into account the risk associated with offbalance sheet activities.29(c) Supervisors should require that the overall nature of therelationship between the financial conglomerate and the SPE isconsidered including the risk of contagion from the SPE. Thisassessment should go beyond traditional control and influencerelationships.Explanatory comments29.1 A financial conglomerate’s risk management framework andprocesses should cover the full spectrum of risks to the financialconglomerate. This includes risks from regulated and unregulatedentities, including SPEs and off-balance sheet activities. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 181. 29.2 The fact that a financial conglomerate does not own or control theSPE in the traditional sense should not mean that it should not beconsolidated.Other channels of contagion should be considered, such as the provisionof (actual or contingent) liquidity support, reputational risk, and whetherthe assets of the SPE previously belonged to the financial conglomerateor were third-party assets.29.3 It is important that financial conglomerates assess all economicrisks and business purposes of an SPE throughout the life of atransaction, distinguishing between risk transfer and risk transformation.Financial conglomerates should be particularly aware that, over time, thenature of these risks can change.Supervisors should require such assessment to be ongoing and thatmanagement has sufficient understanding of the risks.29.4 Financial conglomerates should have the capability to aggregate,assess and report all their SPE exposure risks in conjunction with allother firm-wide risks.29.5 Supervisors should regularly oversee and monitor the use of all SPEactivity and assess the implications for the financial conglomerate of theactivities of SPEs, in order to identify developments that can lead tosystemic weakness and contagion or that can exacerbate pro-cyclicality. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 182. 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 more:www.solvency-ii-association.com/Solvency_II_Speakers_Bureau.html _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 183. 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 www.solvency-ii-association.com
  • 184. 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 www.solvency-ii-association.com
  • 185.  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 www.solvency-ii-association.com
  • 186. 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 www.solvency-ii-association.com
  • 187. 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 course:www.solvency-ii-association.com/Certified_Solvency_ii_Training.htm _________________________________________ Solvency ii Association www.solvency-ii-association.com
  • 188. _________________________________________ Solvency ii Association www.solvency-ii-association.com

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