Solvency ii Association   1200 G Street NW Suite 800 Washington, DC 20005-6705 USA       Tel: 202-449-9750 www.solvency-ii...
regimes and will foster further convergence of practices of insurancesupervision worldwide.Insurance markets are increasin...
internationally coherent framework exists for the supervision of suchlarge, global groups.I would like to stress that EIOP...
Comframe should not be another regime on top of the already existentones.The local regimes should evolve to comply with Co...
Insurance companies or groups that engage in non-traditional, or non-insurance, activities (for example: CDS, financial gu...
language, which will help us to promote stability of the financialmarkets, to enhance their transparency and to foster con...
Interesting comments for the ComFrameA compilation of comments on a common framework for thesupervision of internationally...
ABIR also recommends that a smaller number of groups -say the 20largest–be targeted with COMFRAME; experiment first, learn...
China, China Insurance Regulatory CommissionThe indentifying standards of IAIG include size, international activity,and co...
Moreover, EIOPA thinks that some redundancies with ICPs notionscould be deletedUK, Association of British InsurersThe crit...
The criteria used to identify IAIGs should be clear and focused onidentifying those entities which have a large presence i...
ComFrame has three main objectives which include:1) Developing methods of operating group-wide supervision of IAIGs;2) Est...
Solvency IIIn 2011, EIOPA focusedon preparing the final setof regulatory measures forSolvency II, the draft standards and ...
Finally, since the creation of EIOPA’s Insurance and ReinsuranceStakeholder Group, EIOPA has benefited from their expertis...
Consumer protection and financial innovationEIOPA has considered, from day one, consumer protection as acornerstone of its...
community vis-a-vis insurance groups operating across borders for thebenefit of both group and solo supervision. In 2011, ...
This was achieved by specific and regular market monitoring,information sharing and discussions on mitigating measures in ...
In June and December 2011, EIOPA published its two semiannualFinancial Stability Reports containing an assessment of the e...
Following the recommendations of the Committee of Wise Men, theEuropean Commission initiated a reform, which was supported...
EIOPA’s core responsibilities are to support the stability of the financialsystem, ensure the transparency of markets and ...
bringing a modern risk oriented, economic and principle based set ofrules.One of the main tasks for EIOPA in the coming ye...
Financial Requirements Committee (FinReq)The Financial Requirements Committee (FinReq) focused ondeveloping draft technica...
Internal Models Committee (IntMod)The Internal Models Committee (IntMod) focused on developing drafttechnical standards an...
Occupational Pensions Committee (OPC)The main focus of the Occupational Pensions Committee (OPC) workbetween April 2011 an...
- Bermuda and- Japan.The supervisory systems of Switzerland and Bermuda were assessedwith reference to reinsurance, inclus...
• collecting data on consumer trends among its members so as toprepare an initial overview, analysing and reporting on tho...
These peer reviews are due to be completed in 2012.Task Force on Crisis ManagementIn 2011 a Task Force on Crisis Managemen...
FSC also contributed to the two half-year Financial Stability Reportsmonitoring both sectors (IORPs and insurance undertak...
• The Omnibus II Directive is under discussion in the EuropeanParliament and Council of the European Union following the l...
While deliberations were taking place in the European Parliament andthe Council of the European Union on OMDII, the Commis...
Subject to the conclusion of the negotiations on OMDII and theimplementing measures, EIOPA plans public consultation on th...
Areas in which EIOPA prepared draft standards and guidelinesduring 2011:• Solvency capital requirements for standard formu...
members of the European Economic Area participated voluntarily in thissimulation exercise, providing detailed quantitative...
For most business lines, the report published in December 2011facilitated joint recommendations for amendments of the fact...
In the second half of 2011, EIOPA continued working with industryrepresentatives on zoning and reinsurance standards, as w...
Valuation of assets and liabilities (excluding technicalprovisions)Informal pre-consultations were held on draft standards...
supervisory review process, capital add-ons and extension of the recoveryperiod in deteriorating market conditions as well...
a satellite exercise assessing the effects of a prolonged period of lowinterest rates.This satellite exercise is often ref...
On the liability side, non - life risks were more critical, triggered byincreased claims inflation and natural disasters.R...
In addition, an increased number of insurers would see their capitalposition deteriorate with solvency rates only slightly...
Data availability for dashboard purposes is expected to further improvewith the introduction of Solvency II reporting from...
This has included initiatives to harmonise and streamline groupsupervision for cross-border groups and enhance co-operatio...
Some 6 Colleges were chaired by the Swiss Financial Market SupervisoryAuthority (FINMA) as group supervisor.During the set...
• The Colleges are making great efforts to prepare for theimplementation of the Solvency II Directive, in particular the p...
During 2011, EIOPA staff observed overall significant differences in thelevel of information exchange.Areas for improvemen...
This approach is seen as the most efficient way of carrying out regularmonitoring and preparing Board of Supervisors’ deci...
EIOPA will contribute to the revision of the Insurance MediationDirective (IMD), by providing a respective advice to the E...
recommendations with a view to promoting the safety and soundness ofmarkets and convergence of regulatory practice.Financi...
At the same time, EIOPA will continue to develop its internationalrelations by holding regulatory dialogues and maintainin...
List of the Members and Observers of the EIOPA Board ofSupervisors            _________________________________________   ...
_________________________________________          Solvency ii Association     www.solvency-ii-association.com
Agathe Côté: Modelling risks to the financialsystemRemarks by Ms Agathe Côté, Deputy Governor ofthe Bank of Canada, to the...
System-wide risk has been a focus of attention at the Bank of Canada,and at other central banks, for some time.Ten years a...
I will then discuss two state-of-the-art quantitative models that we havedeveloped to improve our assessment of risks to t...
amplify the adverse effects of the initial shock.For instance, uncertainty about the viability of counterparties can lead ...
warning indicators are used mainly to identify areas where more detailedinvestigation may be warranted.They provide an obj...
Combining indicators can produce better signals with fewer false alarmsand undetected crises.For example, research shows t...
These models can also be used to assess the potential impact of policytools or regulatory actions in mitigating financial ...
Using HRAM, we estimate that if interest rates were to rise to 4.25 percent by mid-2015, the share of highly indebted hous...
Despite the model’s strengths, we continue to enhance our analysis byimproving HRAM.Expanding the behavioural aspects of t...
The financial crisis illustrated the significant risks associated with adeterioration of funding liquidity.The collective ...
The fact that the model is able to replicate this important stylized factdemonstrates that it has significant potential as...
In addition to assessing risks, MFRAF can be used to examine themerits of policy or regulatory initiatives such as capital...
Solvency ii News September 2012
Solvency ii News September 2012
Solvency ii News September 2012
Solvency ii News September 2012
Solvency ii News September 2012
Solvency ii News September 2012
Solvency ii News September 2012
Solvency ii News September 2012
Solvency ii News September 2012
Solvency ii News September 2012
Solvency ii News September 2012
Solvency ii News September 2012
Solvency ii News September 2012
Solvency ii News September 2012
Solvency ii News September 2012
Solvency ii News September 2012
Solvency ii News September 2012
Solvency ii News September 2012
Solvency ii News September 2012
Solvency ii News September 2012
Solvency ii News September 2012
Solvency ii News September 2012
Solvency ii News September 2012
Solvency ii News September 2012
Solvency ii News September 2012
Solvency ii News September 2012
Solvency ii News September 2012
Solvency ii News September 2012
Solvency ii News September 2012
Solvency ii News September 2012
Solvency ii News September 2012
Solvency ii News September 2012
Solvency ii News September 2012
Solvency ii News September 2012
Solvency ii News September 2012
Solvency ii News September 2012
Solvency ii News September 2012
Solvency ii News September 2012
Solvency ii News September 2012
Solvency ii News September 2012
Solvency ii News September 2012
Solvency ii News September 2012
Solvency ii News September 2012
Solvency ii News September 2012
Solvency ii News September 2012
Solvency ii News September 2012
Solvency ii News September 2012
Upcoming SlideShare
Loading in...5
×

Solvency ii News September 2012

1,549

Published on

Solvency ii News September 2012

Published in: Education
0 Comments
0 Likes
Statistics
Notes
  • Be the first to comment

  • Be the first to like this

No Downloads
Views
Total Views
1,549
On Slideshare
0
From Embeds
0
Number of Embeds
0
Actions
Shares
0
Downloads
1
Comments
0
Likes
0
Embeds 0
No embeds

No notes for slide

Transcript of "Solvency ii News September 2012"

  1. 1. Solvency ii Association 1200 G Street NW Suite 800 Washington, DC 20005-6705 USA Tel: 202-449-9750 www.solvency-ii-association.comDear member,Today we will start from an interestingspeechGabriel Bernardino, Chairman of EIOPACreating a global insurance supervisory LanguageConference on Global Insurance SupervisionGood evening, ladies and gentlemen,On behalf of EIOPA I would like to thank the International Center forInsurance Regulation for the cooperation and efforts in organisingtogether with us this Conference on GlobalInsurance Supervision.I am very happy to see today so many colleaguesfrom the supervisory authorities as well asprominent experts and executive officers of theinsurance industry.Our purpose with this Conference is to create aplatform of discussion and exchange of viewsabout the international context of insurancesupervision.Your presence and contribution to this event is key to its success andwill certainly contribute to a better understanding of the different _________________________________________ Solvency ii Association www.solvency-ii-association.com
  2. 2. regimes and will foster further convergence of practices of insurancesupervision worldwide.Insurance markets are increasingly global.Many insurance groups have nowadays a huge part of their revenuescoming from business outside their home countries.This creates new opportunities but also new challenges for insurers, butalso for supervisors.The promotion of sound and stable insurance markets calls for moreinternational cooperation.We firmly believe that the best way toreinforce financial stability and consumerprotection is to develop strong globalregulatory and supervisory standards.This will create a level playing field forinternational players, foster a commonlanguage between supervisors and improveinternational cooperation and informationexchange.I would like to share with you some views onthe ways of improving the efficiency ofsupervision from a global perspective.ComFrame ( Common Framework for theSupervision of Internationally ActiveInsurance Groups (IAIGs) - ComFrame is an integrated, multilateraland multidisciplinary framework for the group(wide supervision ofinternationally active insurance groups.ComFrame was initiated in response to the recognition that, despite thegrowing relevance of IAIGs in the global insurance marketplace, no _________________________________________ Solvency ii Association www.solvency-ii-association.com
  3. 3. internationally coherent framework exists for the supervision of suchlarge, global groups.I would like to stress that EIOPA is highly committed to contribute tothe establishment of such standards and, in this regard, we consider ourparticipation in the IAIS very important. EIOPA is actively contributingto the work of ComFrame.We consider it necessary to enhance regulatory capital requirements inorder to achieve adequate consumer protection on a global level.Of course, while calling for this measure, we take into account differentperspectives and developments worldwide.Seen historically, the EU had experienced comparable discussions adecade ago.We fully support the move to enhanced group-wide supervision.Cooperation between supervisors in colleges is essential for the propersupervisory approach to Internationally Active Insurance Groups.We believe that information sharing and supervisory cooperation underconditions of professional secrecy is a key, determinative element ofeffective supervision.We need more shared supervision.Furthermore, Comframe should comprise a capital element, establishingstrong principles for group capital calculations concerning the risksincluded, the metrics used to assess them and the overall level ofconfidence.Without this consistency, there is no level playing field internationally.It is not about one unique system, but about a set of strong principlesthat would deliver a range of closer and compatible systems. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  4. 4. Comframe should not be another regime on top of the already existentones.The local regimes should evolve to comply with Comframe.This is my vision. I recognize that we cannot deliver this immediately,but at the IAIS we need to set a timetable and concrete milestones todevelop this concept in a step by step approach.We need to be courageous and open-minded.We need to be open to change and evolution because the industry realityis also evolving and changing.An extra effort needs to be done by all of us because like CharlesKettering (a famous American inventor) said one day: “People are veryopen minded about new things as long as theyre exactly like the oldones.”Systemic risk in insuranceThe crisis prompted a new look at systemic risk, including in theinsurance sector.The identification and regulation of Globally Systemically ImportantInsurers is currently being discussed under the umbrella of the FinancialStability Board and the IAIS.EIOPA is keen to contribute to a robust identification process of G-SIIsand to develop appropriate regulatory and supervisory tools to deal withtheir characteristics.Traditionally, systemic risk was a banking concept.However, the recent crisis showed us that certain activities developedunder the insurance sector can also pose systemic risk. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  5. 5. Insurance companies or groups that engage in non-traditional, or non-insurance, activities (for example: CDS, financial guarantees orleveraging assets to enhance investment returns through securitieslending are more vulnerable to financial market developments and,importantly, more likely to amplify, or contribute to, systemic risk.Of course, this assessment may change over time, depending on theinnovations and changes in insurance business models, especially in lifeinsurance, as well as in the complex interactions between insurancegroups and financial markets.We should be especially attentive to any kind of maturity transformationand leveraging occurring in the insurance sector.As a consequence, the identification of a systemically important insureras such, should be a direct reflection of its source of systemicimportance.While the size of traditional insurance activity is still an important factor,it should not be the dominant factor in the identification process.Clearly, the non-traditional and non-insurance activities and the degreeof interconnectedness with other components of the financial system aremore relevant from a systemic point of view.Consequently, the differences between insurers and banks in the impactof failures suggest that requirements for loss absorbency and resolutionregimes for insurers should accept these salient differences and proposesolutions that differentiate accordingly.As a conclusion I would like to underline that we should have noillusions: the creation of global insurance supervisory standards is a verylong process that is complicated by the difference of cultures and unevendevelopment of supervisory systems in different countries.But it is important that the regulators all over the world are willing toreach mutual understanding and to develop a common supervisory _________________________________________ Solvency ii Association www.solvency-ii-association.com
  6. 6. language, which will help us to promote stability of the financialmarkets, to enhance their transparency and to foster consumerprotection.Together we can achieve these objectives. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  7. 7. Interesting comments for the ComFrameA compilation of comments on a common framework for thesupervision of internationally active insurance groups,known as ComFrame by the International Association of InsuranceSupervisors (IAIS)Bermuda, Association of Bermuda Insurers and ReinsurersABIR does not support the current proposal to include companies thatdo business in 3+ jurisdictions as the first basis on which to determine acompany may qualify as an IAIG.(Note: IAIG stands for Internationally Active Insurance Group)(Note: ABIR stands for Association of Bermuda Insurers andReinsurers)ABIR would respectfully submit that one of the objectives of ComFrameis to develop harmonization of the application of group supervision andin this regard, if for example, a group is operating in 3 jurisdictionswithin the EEA, then under the proposed regime harmonization inprinciple will have been already statutorily mandated, thus the purposeof introducing another group supervisory regime is not clear.We would propose that an IAIG is one which operates with legal entitiesin multiple jurisdictions which have separate and distinct regulatorysystems across 3+ supervisory frameworks; for example, Canada; US;Bermuda; India, etc.ComFrame should be applied only to those internationally active groupsthat have a global footprint and operate with legal entities injurisdictions on multiple continents.The EU and the United States would each count as a single jurisdictionsince they operate with a common cross-state regulatory system. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  8. 8. ABIR also recommends that a smaller number of groups -say the 20largest–be targeted with COMFRAME; experiment first, learn from thatbefore expanding the net.ABIR also is concerned with the proposed "constrained supervisorydiscretion" which grants "involved supervisors" the ability to consideran insurance group an IAIG even if it does not meet some of theproposed criteria or to exclude it as an IAIG.This type of discretion creates uncertainty for groups since it may be"deemed to be an IAIG even if it doesnt meet the criteria.Whilst the ComFrame Paper provides examples of when this may beemployed, the proposal is too far reaching.Given the proposed constrained supervisory discretion on the part of thesupervisors, does ComFrame also propose an appeals process by whichan identified IAIG can seek to have that designation lifted?Canada, Office of the Superintendent of Financial InstitutionsOSFI believes that the current criteria and process may be tooprescriptive or mechanical.Further, OSFI discourages developing a discrete list of IAIGs that isdetermined mainly using quantitative requirements.Instead, a general definition as to the nature, size, complexity,international activity and risk profile of institutions to which ComFrameshould apply would assist the supervisor in applying supervisorydiscretion to determine IAIGs.Rather than ranking insurers quantitatively and determining a cut-offpoint for IAIGs, the general definition should be applied on acontinuum. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  9. 9. China, China Insurance Regulatory CommissionThe indentifying standards of IAIG include size, international activity,and constrained discretion, which can reasonably identify insurancegroup companies with international activity and the identificationprocesses are comprehensive and reasonable.In our opinion, the "constrained discretion" should be prudently usedwhile taking into consideration the development stage of each countrysinsurance market and the nature, function and risk condition ofinsurance groups.EU, European Insurance and Occupational Pensions Authority(EIOPA)EIOPA strongly supports the work of the IAIS to develop a set ofinternationally consistent standards for the regulation and supervision ofIAIGs.EIOPA would like to thank the IAIS for the work conducted up to now.Let us first express that EIOPA considers the restructuring of theComFrame Paper to be an important improvement from the point ofview of readability, focus, addressee perspective, among others.In general the ComFrame criteria and process for identifying IAIGsseem to be appropriate.However there are no explicit rules to define the Head of the IAIG incase where there is no legal entity that controls or exerts dominantinfluence over the other elements of the IAIG.Another aspect which is not fully explained refers to cases in whichentities may be excluded from supervision.The ComFrame only refers to the principle of proportionality whereasclearer and more detailed guidance would be helpful. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  10. 10. Moreover, EIOPA thinks that some redundancies with ICPs notionscould be deletedUK, Association of British InsurersThe criteria are too wide - insurers that are active only in countries thatare part of a single regulatory and supervisory regime should not beclassed as being internationally active.ComFrame should bring clarity to regulation and supervision of groupswhose individual legal entities operate under multiple regulatory regimes- where a group is active in several countries which are all covered by thesame regime, this need does not arise.It should not take three years before a designation as an IAIG can beretracted - this would lead to a situation where, for example, an insurerthat had previously been designated an IAIG but had made significantchanges to its business and was no longer internationally active in ameaningful way would still be subject to ComFrame for two years to noobvious benefit for policyholders, the company or the supervisors.In contrast other non-internationally active insurers operating on anidentical basis but which had not previously been an IAIG would not besubject to ComFrame.If an insurer ceases to meet the criteria for an IAIG then neither thecompany nor supervisors will materially benefit from the application ofComFrame.An insurers designation as an IAIG or not should be reviewed andupdated at least annually.USA, NAICThe process for identifying IAIGs appears to be collaborative in natureand indicative of how ComFrame, as a working framework, shouldoperate. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  11. 11. The criteria used to identify IAIGs should be clear and focused onidentifying those entities which have a large presence internationally.The criteria should be simple and allow the involved supervisors toadjust using their judgment if circumstances necessitate a differentanswer ("constrained supervisory discretion").The criteria currently under consideration by the IAIS attempts to strikea balance but should be carefully reviewed with these objectives in mind.As discussion on future steps (Field Testing, Implementation, etc.)progresses over the next year, the criteria and process for identifyingmay need to be reassessed to ensure it is appropriate to meet theintended objectives.With respect to the current draft, consideration should be given as towhether the criteria for the number of jurisdictions in which an IAIGoperates should include threshold percentage of market share.This could either be part of the criteria itself or part of the supervisorydiscretion process.To read more:http://iaisweb.org/db/content/3/16037.pdfNote:ComFrame is a major project of the IAIS.While the ultimate role of ComFrame remains under discussion anddevelopment, the intent is given by its name —a common framework —one that lays out how supervisors around the globe can work together tosupervise internationally active insurance groups (IAIGs) and closeregulatory gaps.IAIGs are the largest, most complex insurance entities. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  12. 12. ComFrame has three main objectives which include:1) Developing methods of operating group-wide supervision of IAIGs;2) Establishing a comprehensive framework for supervisors to addressgroup-wide activities and risks, and3) Fostering global convergence. ComFrame is neither intended to be aforum to create prescriptive ways to promote a particular means forsolvency standards, nor to create additional layers of regulation.ComFrame is expected to evolve over time.It will be developed over a three-year period with the DevelopmentPhase completed by the end of 2013.The IAIS will issue a comprehensive report detailing the end of theDevelopment Phase, following which there will be one or more impactassessments of both qualitative and quantitative requirements for IAIGs. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  13. 13. Solvency IIIn 2011, EIOPA focusedon preparing the final setof regulatory measures forSolvency II, the draft standards and guidelines.One of the main achievements of EIOPA in 2011 was the report on theFifth Quantitative Impact Study (QIS5) summarising the potentialimpact of the detailed implementing measures to be drafted for theSolvency II regulatory framework.QIS5 has been the most ambitious and comprehensive impact study evercarried out in the financial sector, with the direct involvement of morethan 2500 entities and 100 supervisors from member states and EIOPA,working together for almost a full year.EIOPA launched official public consultations in 2011 in two areas inwhich early discussion with and preparation by the industry areparticularly important.These consultations were on the draft standards and guidelines onreporting and disclosure, and on guidelines on Own Risk and SolvencyAssessment (ORSA).At the end of 2011, EIOPA submitted additional advice to the EuropeanCommission on the calibration of the non-life underwriting risk module.In the area of catastrophe risk, EIOPA made its final recommendationfor the implementing measures on a number of outstanding non-life andhealth catastrophe risk issues.Several task forces concluded their work in 2011, resulting in thepublication of the following reports: “Calibration of the Premium andReserve Risk Factors in the Standard Formula of Solvency II” and the“Report of the Task Force on Expected Profits arising from FuturePremiums”. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  14. 14. Finally, since the creation of EIOPA’s Insurance and ReinsuranceStakeholder Group, EIOPA has benefited from their expertise and widerange of views and interests, and actively involved its members in majoraspects of Solvency II.Occupational pensionsThe main focus of EIOPA’s work on occupational pensions in 2011 wasdeveloping EIOPA’s response to the Call for Advice from the EuropeanCommission on the review of Directive 2003/41/EC on the activities andsupervision of institutions for occupational retirement provision (IORPDirective).The work on the Call for Advice was organised in four sub-groups, allworking in parallel, but all reporting to the Occupational PensionsCommittee (OPC).In 2011, EIOPA also completed number of survey-based reports onreporting requirements, risks related to DC schemes and pre-enrolmentinformation.These surveys were conducted to provide a common technical basis forresponding to the Call for Advice.During 2011, EIOPA carried out two public consultations on its draftadvice.The first between 8 July 2011 and 15 August 2011 on selected aspects ofthe Call for Advice.The second, between 25 October 2011 and 2 January 2012 on the entiredraft advice.EIOPA also submitted during the year 2011 its input to the ESRB ondata requirements for IORP and published its recurrent report on marketdevelopments. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  15. 15. Consumer protection and financial innovationEIOPA has considered, from day one, consumer protection as acornerstone of its work and an area where a difference has to be made,and EIOPA has been proactive in the area of consumer protection andfinancial innovation.In the course of 2011, the Authority prepared “The Proposal forGuidelines on Complaints- Handling by Insurance Undertakings”, theReport on Best Practices by Insurance Undertakings in handlingcomplaints and finalised a “Report on Financial Literacy and EducationInitiatives by Competent Authorities”.EIOPA also collected data on consumer trends among its members toprepare an initial overview, analysing and reporting on those trends.The Authority also provided relevant input to the EuropeanCommission’s revision of the Insurance Mediation Directive (IMD) bycarrying out an extensive survey of sanctions (both criminal andadministrative) provided for in national laws for violations of IMDprovisions.External commitment, including benefiting from the expert input ofEIOPA’s two Stakeholder Groups and holding EIOPA’s firstConsumer Strategy Day, was also crucial to EIOPA achieving its goals in2011.Colleges of Supervisors and cross-border crisis managementand resolutionEIOPA’s tasks go beyond pure regulatory work, and include concreteoversight responsibilities, including an enhanced role as members of thedifferent colleges of supervisors.The overall strategic target of EIOPA’s College work is to consolidatethe position of the European Economic Area (EEA) supervisory _________________________________________ Solvency ii Association www.solvency-ii-association.com
  16. 16. community vis-a-vis insurance groups operating across borders for thebenefit of both group and solo supervision. In 2011, around 89 insurancegroups with cross border undertakings were registered in the EEA.During the year, Colleges of Supervisors having at least one actualmeeting or teleconference were organised for 69 groups.A total of 14 national supervisory authorities acted as group supervisorsto organise the events.During the setup phase in the first year after its establishment, EIOPAattended College meetings and/or teleconferences of 55 groups.In early 2011, a set of interim procedures for dealing with emergencysituations was developed by EIOPA in conjunction with the other ESAs.A seconded national expert in crisis management was appointed inMarch 2011, and work then commenced on the development of apermanent crisis management framework by EIOPA.Key to this was the development of a strategic policy on crisismanagement.In the end of 2011 a Task Force on Crisis Management delivered acomprehensive, decision-making framework on crisis pre-emption andcrisis management.Financial stabilityThe common theme of EIOPA’s financial stability initiatives in 2011 wasto identify, at an early stage, trends, potential risks and vulnerabilitiesstemming from micro and macroeconomic developments, and, wherenecessary, to inform the relevant EU institutions. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  17. 17. This was achieved by specific and regular market monitoring,information sharing and discussions on mitigating measures in theFinancial Stability Committee (FSC).In line with this objective, EIOPA’s FSC set up its first (pilot) riskdashboard in October 2011, containing a common set of quantitative andqualitative indicators that help to identify and measure systemic risk.This dashboard is to be developed further as a joint effort of the ESAsand the ESRB.In the course of 2011 EIOPA has been an active member of the ESRBSteering Committee that was established in order to assist in thedecision-making process of the ESRB.EIOPA also was taking part in the ESRB Advisory Technical Committee(ATC) and its technical subcommittees with the main focus onidentifying potential systemically important issues in the sectors ofinsurance and IORPs.Furthermore, EIOPA participated in the joint ATC and AdvisoryScientific Committee (ASC) expert group dealing with the regulatorytreatment of sovereign exposures.In 2011, the three ESAs and the ESRB signed a joint “Agreement on theestablishment at the ESRB Secretariat of specific confidentialityprocedures in order to safeguard information regarding individualfinancial institutions and information from which individual financialinstitutions can be identified”.EIOPA also began designing a database of current and historical datafor IORPs and insurance and reinsurance undertakings in the EuropeanUnion.During 2011, EIOPA conducted harmonised, pan-European core andlow-yield stress tests for the insurance sector in cooperation with theESRB, ECB and EBA. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  18. 18. In June and December 2011, EIOPA published its two semiannualFinancial Stability Reports containing an assessment of the economicsoundness of the European insurance, reinsurance and IORPs.In December 2011, EIOPA put out for public consultation a set of datareporting templates necessary for regularly assessing sectoral risk andmonitoring financial developments once Solvency II enters into force.EIOPA OverviewIntroductionThe European Insurance and Occupational Pensions Authority(EIOPA) was established as a result of the reforms of the structure ofsupervision of the financial sector of the European Union (EU) thatfollowed the financial crisis of 2007, as the crisis demonstrated that thepre-existing 3L3 Committees (CEIOPS, CEBS and CESR) had reachedtheir limit.Before and during the financial crises of 2007 and 2008, the EuropeanParliament called for a move towards greater European supervisoryintegration in order to ensure a true level playing field for all players atthe level of the European Union and to reflect the increasing integrationof the financial markets of the EU.In response to the global financial crisis, the European Commissiontasked a High Level Group (Committee of Wise Men), chaired by MrJacques de Larosiere, to consider how the European supervisoryarrangements could be strengthened, both to better protect EU citizensand to rebuild trust in the financial system.Among its many conclusions, the Group stressed that supervisoryarrangements should not only concentrate on the supervision ofindividual firms, but also place emphasis on the stability of the financialsystem as whole. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  19. 19. Following the recommendations of the Committee of Wise Men, theEuropean Commission initiated a reform, which was supported by theEuropean Council and the European Parliament.As a result, the supervisory framework was strengthened to mitigate therisk and severity of future financial crises.EIOPA is part of a European System of Financial Supervision (ESFS),the purpose of which is to ensure supervision of the EU financial system.The ESFS comprises the three European Supervisory Authorities(ESAs): the European Banking Authority (EBA), based in London, theEuropean Securities and Markets Authority (ESMA), based in Paris, andEIOPA, based in Frankfurt, as well as the European Systemic RiskBoard (ESRB), based in Frankfurt, and the competent or supervisoryauthorities in the EU Member States as specified in the legislationestablishing the three ESAs.EIOPA’s main goals are:• To better protect consumers, thus rebuilding trust in the financialsystem;• To ensure a high, effective and consistent level of regulation andsupervision, taking account of the varying interests of all Member Statesand the different nature of the financial institutions;• To achieve a greater harmonisation and coherent application of therules applicable to the financial institutions & markets across theEuropean Union;• To strengthen oversight of cross-border groups;• To promote a coordinated European Union supervisory response. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  20. 20. EIOPA’s core responsibilities are to support the stability of the financialsystem, ensure the transparency of markets and financial products andprotect policyholders, pension scheme members and beneficiaries.EIOPA is commissioned to monitor and identify trends, potential risksand vulnerabilities at the micro-prudential level, across borders andacross sectors.EIOPA is an independent advisory body to the European Parliament,the Council of the European Union and the European Commission.To account for the specific conditions in the national markets and thenature of the financial institutions, the European System of FinancialSupervision is an integrated network of national and Europeansupervisory authorities that provides the necessary links between themacro and micro prudential levels, leaving day-to-day supervision to thenational level.EIOPA is governed by its Board of Supervisors, whose members are theheads of the relevant national authorities in the field of insurance andIORPs in each Member State.The European Union’s national supervisory authorities are a source ofexpertise and information in the field of insurance and IORPs.Policy Working GroupsThe majority of Policy Working Groups dealt with insurance andreinsurance-related issues, in particular Solvency II.Two other Working Groups in the policy area dealt with IORPs(IORP Directive) and equivalence-related issues.Solvency II Working GroupsThe Solvency II project is completely reshaping the supervisory andregulatory framework for insurance and reinsurance companies, _________________________________________ Solvency ii Association www.solvency-ii-association.com
  21. 21. bringing a modern risk oriented, economic and principle based set ofrules.One of the main tasks for EIOPA in the coming years is to prepare thenew supervisory regime for insurance and reinsurance undertakings andparticularly to conduct all the necessary work for implementation of theEU Directive on the taking-up and pursuit of the business of insuranceand reinsurance (Solvency II).During 2011, the Solvency II Working Groups developed draft standardsand guidelines which are likely to be required by the Omnibus IIDirective, and which EIOPA considers as essential for ensuring theexistence of convergent supervisory practices from Solvency II’s first dayof entry into force.Pre-consultations with selected stakeholders were held as part of thecontinuous informal discussion with stakeholders while awaitingconfirmation of the formal legal basis for public consultation on thestandards.Each Working Group contributed to EIOPA’s training programme forsupervisors and, where relevant, Working Groups were involved in thediscussions conducted by the European Commission on implementingmeasures.Working Groups contributed to those areas of each other’s work thatrequired a cross-working group perspective, such as governance orreporting.Insurance Groups Supervision Committee (IGSC)The Insurance Groups Supervision Committee (IGSC) focused ondeveloping draft technical standards and guidelines for the convergentimplementation of Solvency II in the areas of group solvencycalculations, intra-group transactions and risk concentration, thecooperation and exchange of information in Colleges, and the treatmentof third country branches. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  22. 22. Financial Requirements Committee (FinReq)The Financial Requirements Committee (FinReq) focused ondeveloping draft technical standards and guidelines for the convergentimplementation of Solvency II in the areas of own funds, technicalprovisions, and the standard formula for capital requirements, includingthe use of undertaking-specific parameters.FinReq contributed to the development of calibration factors for non-lifeunderwriting risk and catastrophe risk.Internal Governance Supervisory Review and ReportingCommittee (IGSRR)The Internal Governance, Supervisory Review and Reporting Committee(IGSRR) focused on developing draft technical standards and guidelinesfor the convergent implementation of Solvency II in the areas of systemof governance, including Own Risk and Solvency Assessment (ORSA),transparency and accountability of supervisory authorities, publicdisclosure and supervisory reporting, and valuation of assets andliabilities (other than technical provisions).Public consultation on the ORSA guidelines and reporting anddisclosure requirements was launched at the end of 2011.IGSRR also started working on guidelines for external audit, thesupervisory review process, capital add-ons, and the extension of therecovery period in the exceptional fall in financial markets.IGSRR prepared EIOPA’s contribution to the International FinancialReporting Standard (IFRS) setting process and to the EU endorsementprocess. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  23. 23. Internal Models Committee (IntMod)The Internal Models Committee (IntMod) focused on developing drafttechnical standards and guidelines for the convergent implementation ofSolvency II in the areas of tests and standards for full and partial internalmodels, requirements for the approval process, and the policy forintroducing changes to the model.In order to increase supervisory convergence and to prepare industry andsupervisors for the use of internal models under Solvency II, IntModimplemented initiatives for enhancing supervisory consistency acrossEurope in the pre-application process for internal models, and forensuring adequate cooperation between supervisors when assessinginternal models.These initiatives involved practical meetings between operationalsupervisors and training activities.Task Force on Expected Profits arising from Future Premiums(EPIFP)This task force was created to develop a common understanding of theelement of expected profits included in future premiums (EPIFP) so asto advise the Commission on the drafting of implementing measuresafter the fifth quantitative impact study (QIS5).It was composed of representatives of industry, the EuropeanCommission and EIOPA members and discussed possible ways ofharmonising the calculation of EPIFP under Solvency II.EIOPA submitted a report to the European Commission whichultimately only represented the views of its own members. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  24. 24. Occupational Pensions Committee (OPC)The main focus of the Occupational Pensions Committee (OPC) workbetween April 2011 and the end of the year was developing EIOPA’sadvice to the European Commission on the review of the IORP Directivein response to the Call for Advice.Beyond this, OPC own initiative projects in 2011 included thepublication of a number of survey - based reports as follows:• ‘Report on reporting requirements to supervisory authorities forIORPs’• ‘Report on market developments 2011’• Two reports on risks relating to members of defined contributionpension schemes (risks faced by members and mechanisms mitigatingthose risks)• ‘Report on pre-enrolment information’ as part of a wider OPCmandate on Packaged Retail Investment Products (PRIPs) and pensionsOther inputs included a contribution to a report on the EuropeanSystemic Risk Board (ESRB) data requirements in respect of IORPs.Equivalence CommitteeIn January 2011, the Equivalence Committee was set up with its maintask being to respond to requests from the European Commission forfinal advice, after full consultation, on the equivalence of third countries’supervisory systems.On 26 October 2011, upon request of the European Commission, EIOPAdelivered its final advice, after full consultation, on the Solvency IIequivalence assessments of the supervisory systems in the followingcountries:- Switzerland, _________________________________________ Solvency ii Association www.solvency-ii-association.com
  25. 25. - Bermuda and- Japan.The supervisory systems of Switzerland and Bermuda were assessedwith reference to reinsurance, inclusion of the third country undertakingin the group solvency calculation and group supervision, while thesupervisory system of Japan was assessed only with reference toreinsurance.The equivalence assessment was based on respective questionnairesfilled in by the relevant supervisory authorities (Swiss FinancialSupervisory Authority – FINMA; Bermuda Monetary Authority – BMA;and the Japan Financial Services Authority – JFSA), followed by a desk-based analysis using EIOPA’s methodology, and onsite visits by EIOPAexperts to each of the three countries.Regulatory Working GroupsCommittee on Consumer Protection and Financial Innovation(CCPFI)In 2011, the Committee on Consumer Protection and FinancialInnovation (CCPFI) supported EIOPA in fulfilling the requirement laiddown in its Regulation of taking a leading role in the area of consumerprotection and financial innovation, as follows:• preparing “Guidelines on Complaints-Handling by InsuranceUndertakings” and “Report on Best Practices by InsuranceUndertakings in handling complaints”.• preparing the “Report identifying Good Practices for Disclosure andSelling of Variable Annuities”.• finalising the “Report on Financial Literacy and Education Initiativesby Competent Authorities”. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  26. 26. • collecting data on consumer trends among its members so as toprepare an initial overview, analysing and reporting on those trends.• carrying out an extensive survey of sanctions (both criminal andadministrative) provided for in national laws for violations of IMDprovisions.Task Force on Insurance Guarantee Schemes (TF-IGS)This task force met in the course of 2011 to prepare the report on thecross-border cooperation mechanisms between IGSs in the EU.In accordance with EIOPA’s mandate to contribute to assessing theneed for a European network of IGSs that is adequately funded andsufficiently harmonised, the report was EIOPA’s input to the EuropeanCommission’s policy - making on IGSs.It summarised the findings from a mapping exercise of the existingmechanisms on cross-border cooperation between the IGSs of MemberStates, and provided general recommendations to the EuropeanCommission in the area of cooperation between IGSs and with theirsupervisors.Oversight Working GroupsReview PanelAt the beginning of 2011, the Review Panel , using the experience andlessons learned from its first peer review exercise completed in 2010,reviewed the methodology for peer reviews in line with the EIOPARegulation.In the middle of the year, the Review Panel started work on three peerreview projects on supervisory practices for pre-application of internalmodels, supervision of branches of EEA insurance undertakings, andsupervision of IORPs. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  27. 27. These peer reviews are due to be completed in 2012.Task Force on Crisis ManagementIn 2011 a Task Force on Crisis Management was established to developEIOPA’s structures for crisis prevention, management and resolution.In December 2011, this task force delivered a comprehensive, decision-making framework that was endorsed by the Board of Supervisors.This framework sets out in detail the processes that EIOPA will follow indischarging its crisis pre-emption and crisis managementresponsibilities under the EIOPA Regulation.Financial Stability Working GroupsFinancial Stability Committee (FSC)The Financial Stability Committee (FSC) focused on monitoring andanalysing developments in the insurance and IORPs sectors.This included in particular the impact of sovereign debt situation insome European countries and also that of other events such as naturalcatastrophes, including the impact of the Japanese earthquake in March2011 and the subsequent devastating tsunami.Furthermore, the FSC developed a 2011 stress test exercise for theEuropean insurance sector, including a subsequent satellite exercise fora low-yield environment.The FSC also developed and implemented the EIOPA risk dashboardbased on quarterly information collected from national supervisors.The FSC contributed to the work of the cross-sector risk subcommitteeof the Joint Committee. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  28. 28. FSC also contributed to the two half-year Financial Stability Reportsmonitoring both sectors (IORPs and insurance undertakings), whichwere also submitted to the EU Economic and Financial Committee(EFC) and the ESRB.Corporate support Working GroupsInformation Technology and Data Committee (ITDC)In 2011, the IT and Data Committee (ITDC) focused on developingEIOPA’s IT and data strategy and, following on from this, it worked onIT specifications and implementation plans.The IT strategy set out the IT-related goals needed to fulfil EIOPA’smission.The Board of Supervisors adopted the IT and data strategy reports at itsOctober 2011 meeting and mandated EIOPA to implement the IT-related goals set out therein.The Board of Supervisors required the ITDC to produce high - level andoutline IT plans and specifications, with particular focus on an EIOPAIT implementation plan.Update on Solvency II• Solvency II is a new regulatory framework providing supervisors withthe appropriate tools for assessing the overall solvency of insurance andreinsurance undertakings by quantitative and qualitative means, thusimproving understanding and management of these undertakings’ risks.• It is based on three pillars: quantitative requirements (pillar I);governance, risk management and supervisory review (pillar II); andsupervisory reporting and public disclosure (pillar III).• The framework directive was published on 17 December 2009. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  29. 29. • The Omnibus II Directive is under discussion in the EuropeanParliament and Council of the European Union following the legislativeproposal from the European Commission on 19 January 2011.• Implementing measures have been discussed between the EuropeanCommission and Member States since the end of 2009.• Standards are being drafted by EIOPA to be endorsed by the EuropeanCommission.• Guidelines are being drafted by EIOPA to ensure the convergentapplication of the regulation.• Date of entry into force of Solvency II: 1 January 2014.Omnibus II Directive and implementing measuresFollowing the creation of EIOPA, the Solvency II Directive requiredrevision to reflect the new supervisory structure; these revisions will formpart of the Omnibus II Directive (OMDII).OMDII will introduce into the Solvency II Directive the necessaryregulatory and supervisory powers for EIOPA to discharge itsresponsibilities.In addition, OMDII also includes transitional measures allowing gradualimplementation of Solvency II.This extension means that the beginning of the regime would be alignedwith the end of the financial year for most insurance undertakings.During 2011 EIOPA continued to provide technical and analyticalsupport to the Commission and gave further input to clarify its previousadvice on the development of the implementing measures for SolvencyII. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  30. 30. While deliberations were taking place in the European Parliament andthe Council of the European Union on OMDII, the Commission,Member States and stakeholders also examined the draft implementingmeasures.Key areas under discussion were the sustainability of long-terminsurance guarantees, the volatility of elements in undertakings’solvency balance sheets, and reporting and disclosure requirements.Standards and guidelinesIn 2011, EIOPA focused on preparing the final set of regulatorymeasures, the draft standards and guidelines.Solvency II will be one of the first projects to benefit directly fromEIOPA’s regulatory powers to draft standards and subsequently toensure consistent implementation of legislation through bindingmediation and oversight of Colleges of Supervisors.Until there is agreement on the proposals for OMDII Directive, EIOPAwill not have complete certainty on the scope of its powers for draftingthe standards for Solvency II and the detail of the regulatory provisionswhich the standards and guidelines are intended to support.Consequently, it was important for EIOPA to monitor the variousOMDII proposals and thus identify the standards which the Authorityexpects it will have to draft before Solvency II enters into force on 1January 2014.During 2011, EIOPA also identified those areas in which it is essential tohave guidelines in place before the entry into force of Solvency II.EIOPA is committed to effective consultation and communication withits stakeholders to improve the quality of the regulatory provisions andassist the industry in preparing for the new regime. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  31. 31. Subject to the conclusion of the negotiations on OMDII and theimplementing measures, EIOPA plans public consultation on thepackages of draft standards and guidelines during 2012.In 2011, EIOPA launched official public consultations in two areas inwhich early discussion with and preparation by the industry areparticularly important.These consultations were on the draft standards and guidelines onreporting and disclosure, and on guidelines on Own Risk and SolvencyAssessment (ORSA).In other areas, EIOPA continued its informal pre‑consultations withselected stakeholders (European Insurance and Reinsurance Federation(CEA), Association of Mutual Insurers and Insurance Cooperatives inEurope (AMICE), Chief Risk Officers (CRO) Forum and ChiefFinancial Officers (CFO) Forum, Groupe Consultatif ActuarielEuropeen), thus having an ongoing dialogue with the industry ahead ofthe public consultation.A number of other initiatives were set up specifically to improveEIOPA’s cooperation and exchange of information with its stakeholders.Several task forces completed their work in 2011, which resulted in thepublication of the “Report on the Calibration Factors in the StandardFormula of Solvency II” and the “Report of the Task Force on ExpectedProfits arising from Future Premiums”.Finally, following the creation of EIOPA’s Insurance and ReinsuranceStakeholder Group, EIOPA actively involved its members in majoraspects of Solvency II. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  32. 32. Areas in which EIOPA prepared draft standards and guidelinesduring 2011:• Solvency capital requirements for standard formula as well as forinternal model users; own funds; valuation of technical provisions;valuation of assets and liabilities.• Group supervision.• Supervisory transparency and accountability, reporting and disclosure,external audit.• Governance, ORSA.• Supervisory review process; capital add-ons; extension of recoveryperiod (‘Pillar 2 dampener); finite reinsurance; special purposevehicles.Quantitative Impact Study 5One of the key achievements of EIOPA in 2011 was completion of thereport on the Fifth Quantitative Impact Study (QIS5) in March 2011.The results of the QIS5 exercise were taken into account in discussionson the implementing measures and are being reflected in the drafting ofstandards and guidelines.The QIS5 exerciseIn March 2011, EIOPA delivered to the European Commission a reporton the results of the fifth pan-European quantitative impact studyorganised to inform policymakers on the potential effects of the detailedimplementing measures which are being drafted for the Solvency IIregulatory framework.More than 2 500 individual undertakings and 160 groups from the 30 _________________________________________ Solvency ii Association www.solvency-ii-association.com
  33. 33. members of the European Economic Area participated voluntarily in thissimulation exercise, providing detailed quantitative and qualitativeinputs on the various elements of the future regulation.The study confirmed that overall the industry remained well capitalisedunder the draft provisions and options tested.The study gathered useful input on transitional provisions fordiscounting, the grandfathering of specific elements of own funds, andthe transitional equivalence of third-country regimes, for example.Valuable insight was gained about the characteristics of internal modelsunder development by undertakings, the difficulties in calculating theloss - absorbing capacity of technical provisions and deferred taxes, andthe potential impact of the introduction of an illiquidity premium in thevaluation of technical provisions.The study also covered the treatment of participations; it gatheredinformation on the relevance of expected profit in future premiums, andon the group solvency assessment under the consolidation anddeduction and aggregation methods.The study results highlighted the areas in which further work would bedesirable.This was then initiated by EIOPA as follows: definition of contractboundaries in the valuation of technical provisions; the need to reducecomplexity in certain areas; developments in the calibration ofcatastrophe risk; and the treatment of long-term guarantees in thecontext of Solvency II.A particular topic – the refinement of factors used in non-lifeunderwriting and health non - similar to life underwriting risk modules –was addressed by specific data collection in the QIS5 exercise.The data were analysed using a methodology drawn up by a task force ofsupervisors, actuaries and industry representatives. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  34. 34. For most business lines, the report published in December 2011facilitated joint recommendations for amendments of the factors used inthe QIS5 exercise.EIOPA’s current and future work on the development of draft technicalstandards and guidelines for Solvency II will benefit greatly from thelessons learned during the QIS5 exercise, in particular by enhancing thepracticability and feasibility of the rules for a single rule book ofstandards and guidelines to ensure convergent application of the newsystem.Standard formula capital requirementsEIOPA prepared draft standards and guidelines on the approval processand data quality for undertaking-specific parameters for soloundertakings and groups; methods for the calculation of undertaking-specific parameters for solo undertakings; the loss-absorbing capacityfor deferred taxes and technical provisions; and standard capitalrequirements for health underwriting risk.Informal pre - consultations will be launched and further draft standardsand guidelines developed in 2012.One key area in which EIOPA delivered further advice to theCommission was the calibration of the non-life underwriting riskmodule.The advice was based on a European-wide data request to the industrylaunched in September 2010, and on discussions with industryrepresentatives and the European Commission to consider the mostappropriate calibration methodologies.The results of this work were published in December 2011.In the area of catastrophe risk, following discussions with the industry,EIOPA made its final recommendation on a number of outstanding non-life and health catastrophe risk issues for the implementing measures. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  35. 35. In the second half of 2011, EIOPA continued working with industryrepresentatives on zoning and reinsurance standards, as well as oncatastrophe risk guidelines.Technical provisionsInformal pre-consultations were held on actuarial guidelines for thevaluation of technical provisions.EIOPA began developing the draft standard on the risk-free interest ratecurve and contract boundaries.For the first time, the European Commission tested in QIS5 a risk-freeinterest rate term structure which included a so-called illiquiditypremium.The term structure was based on an adjusted swap rate, and a newextrapolation method was applied for long maturities.During 2011, discussions continued on adjustments to the risk-free ratefollowing the QIS5 results and on the sustainability of long - terminsurance guarantees.EIOPA participated in these discussions organised by the EuropeanCommission with Member State and industry representatives.Proposals emerged from Member States and industry on newadjustments, the so-called counter-cyclical premium and the matchingpremium.These proposals were analysed by EIOPA in the context of developing astandard for the risk - free rate that EIOPA will define and publish.Discussions are expected to continue in 2012. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  36. 36. Valuation of assets and liabilities (excluding technicalprovisions)Informal pre-consultations were held on draft standards and guidelinesconcerning the valuation of assets and liabilities.This included guidelines on the use of mark-to-model techniques andthe compatibility of International Financial Reporting Standards (IFRS)with Solvency II.During 2011, EIOPA also contributed to the process of IFRS standard-setting and subsequent EU endorsement of those standards.Reporting and disclosureIn 2011, EIOPA launched a public consultation on its draft guidelinesand standards for reporting and disclosure.This marked the end of an ongoing and fruitful process of informalconsultation with stakeholders since 2009.Due to the importance of harmonised reporting requirements for theSolvency II project, and also for other areas of EIOPA’s work, such asfinancial stability and the level of preparation that will be required fromthe industry, one of EIOPA’s key aims is to arrive at stable reportingrequirements as soon as possible.Further discussions on specific aspects of the reporting templates andthe frequency of reports are expected to continue in the first half of 2012.Governance and risk management requirementsInformal pre-consultations were held on standards for governance,including ORSA (the latter issue was also subject to public consultationlater on). EIOPA began developing draft standards and guidelines ontransparency and accountability of supervisory authorities and the _________________________________________ Solvency ii Association www.solvency-ii-association.com
  37. 37. supervisory review process, capital add-ons and extension of the recoveryperiod in deteriorating market conditions as well as on external audit.Own fundsInformal pre-consultations were held on draft standards and guidelinesfor ancillary own funds and the classification of own funds.Further work was carried out on the treatment of participations and ring-fenced funds.Internal modelsInformal pre-consultations were held on draft standards and guidelinesfor the following: application processes for internal models; policies forchanging the model; partial internal models; use tests; expert judgments;probability distribution forecasts (PDF); and consistency between themethodology used for the PDF calculation and the methodology used forvaluation of assets and liabilities (e.g. the calculation of technicalprovisions, approximations for calibrations, profit and loss attributions,validation policy and validation tools, documents and the use of externalmodels).Following the publication in 2010 of guidelines supporting the pre-application process for internal models, EIOPA monitored the activitiesof supervisors and industry, using this opportunity to check the day-1applicability of internal models.This included informal practical meetings of supervisors involved in thepre-application process.Insurance stress testAt the end of March 2011, EIOPA launched the second Europe-widestress test for the insurance sector, which was followed in mid-August by _________________________________________ Solvency ii Association www.solvency-ii-association.com
  38. 38. a satellite exercise assessing the effects of a prolonged period of lowinterest rates.This satellite exercise is often referred to as the “lowyield stress test”,and while it was planned in conjunction with the core stress test, itslaunch was postponed to ease the workload of participatingundertakings.In accordance with its regulation, EIOPA shall conduct stress testexercises for the insurance and IORPs sectors at least once a year.The 2011 core and low-yield stress test exercises were to assess thestrength of individual institutions and evaluate the overall resilience ofthe industries to several clearly defined adverse economic and financialmarket environments.The core stress test was launched in March 2011 based on data as of 31December 2010, and the aggregated results of the exercise werepublished in July 2011.Of the 221 insurance and reinsurance groups and undertakings covered,58 groups and 71 single entities reported results to EIOPA, representingapproximately 60% of the whole European insurance market.The results of the stress test exercise confirmed that the insurancemarket in Europe as represented by the 129 participating entities isrobust and is well prepared for potential future shocks.Data showed that approximately 10% (13) of the groups andundertakings which responded did not meet the minimum capitalrequirement (MCR) in the adverse scenario.A total of 8% (10) failed to meet the MCR in the inflation scenario.Overall, EIOPA identified the main drivers of the results as adversedevelopments in equity prices, interest rates and sovereign debt markets. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  39. 39. On the liability side, non - life risks were more critical, triggered byincreased claims inflation and natural disasters.Risks from sovereign bond exposures were covered separately in asupplementary test and the results showed that approximately 5%(6) of the participating groups and undertakings would not meet theMCR.The satellite exercise was launched after the EIOPA 2011 core stress testexercise.This was to analyse the risks that European insurers would face in ascenario where interest rates remained low for a prolonged period oftime, and to understand the development of insurers’ capital positions inadverse economic conditions, as well as to evaluate the overall stabilityof the insurance market.79It was targeted at those insurers that are exposed to interest-ratesensitive products, since a low-interest scenario would significantlyjeopardise the ability of these undertakings to meet the performanceguarantees provided in certain insurance contracts.For this reason, compared to the scope of the core stress test, the sampleof reporting undertakings was slightly reduced to 82 in total.Otherwise, the setup of the low-yield stress test was identical to the coretest, i.e. valuations were based on Solvency II/QIS5 technicalspecifications, and the reference date was 31 December 2010.Based on these results, EIOPA concluded that, on average, the industrywould be adversely affected by a prolonged period of low yields.Depending on the particular shape that such a low-yield curve wouldtake and where the low yields were located along the curve, resultssuggest that 5%-10% of the insurers included in the test would facesevere problems in the sense that their solvency ratio would fall below100%. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  40. 40. In addition, an increased number of insurers would see their capitalposition deteriorate with solvency rates only slightly above the 100%mark, meaning they could become vulnerable to other potential externalshocks.Risk dashboardIn October 2011, the EIOPA FSC set up its first (pilot) risk dashboard, inline with the framework of the joint group on the cooperation betweenthe ESAs and the ESRB on systemic risk.As part of the new European supervisory legislation, EIOPA, the otherESAs and the ESRB are called upon to “develop a common set ofquantitative and qualitative indicators (risk dashboard) to identify andmeasure systemic risk”.This dashboard should be constructed as a joint effort of the ESAs andthe ESRB to give a structured view of risks to the financial sector andthus to facilitate a regular assessment of these risks and possiblemitigation policies.It is envisaged that the risk dashboards of the various institutions bediscussed at ESRB meetings (General Board and/or Advisory TechnicalCommittee) to assess systemic risk.The two main outputs required are risk vulnerabilities and solvencyprofitability (meaning the ability to withstand shocks).A first pilot risk dashboard has been approved by EIOPA but is still in adevelopment phase and needs to be further refined and finalised aftercompletion of the quality control phase.As far as the methodology is concerned, the EIOPA risk dashboard isbased both on public sources (market data) and the confidentialquarterly fast-track reporting from the 30 largest European insurancegroups and it contains both quantitative and qualitative indicators. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  41. 41. Data availability for dashboard purposes is expected to further improvewith the introduction of Solvency II reporting from 2014 onwards.A set of some 50 quantitative indicators form the basis of the riskassessment, and these are mapped into aggregated categories that arealso used by the other ESAs.These are macro risk, credit risk, market risk, funding and liquidity risk,profitability and solvency interlinkages and imbalances, and a specificcategory for insurance risk.The risk dashboard is then obtained through the mechanicalaggregation of these indicators and additional expert judgment which isimportant for filtering out noise from the data and producing crediblerisk assessments.The risk dashboard will be shown in the form of a graph with colourcoding.In addition to work on the risk dashboard, EIOPA launched severalinitiatives during 2011 to improve market monitoring.For example, a daily financial market monitor was launched, and this isnow produced and circulated among EIOPA Staff and EIOPA FSCMembers.A more comprehensive bi-weekly briefing containing risk assessmentsand market analysis was also developed, and regular production of thisbriefing is planned for 2012.OversightDuring 2011 EIOPA undertook significant work in relation to insurancegroups under the current regime (Solvency I), whilst in parallelpreparing itself for the Solvency II framework. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  42. 42. This has included initiatives to harmonise and streamline groupsupervision for cross-border groups and enhance co-operation betweensupervisors within the Colleges of Supervisors.EIOPA has started to attend the meetings of Colleges of Supervisorssince the beginning of 2011, and this has been a vital mechanism forhelping supervisors to prepare for the entry into force of Solvency II, inparticular with regard to the pre-applications for internal models.In March EIOPA published its report on the functioning of colleges, andalso the targets to be achieved during 2011, as included in EIOPA’s 2011Action Plan for Colleges of Supervisors.The overall strategic target of EIOPA’s College work is to consolidatethe position of the EEA supervisory community vis-a-vis the cross-border operating 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 counterpart to the mostly centrally organised andmanaged undertakings.In this respect, EIOPA as a member of the Colleges of Supervisors(“Colleges”) promotes communication, cooperation, consistency, qualityand efficiency in the Colleges.In 2011, 89 insurance groups with cross-border undertakings wereregistered in the EEA.During the year, Colleges of Supervisors with at least one physicalmeeting or teleconference were organised for 69 groups.A total of 14 national supervisory authorities acted as group supervisorsto organise the events. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  43. 43. Some 6 Colleges were chaired by the Swiss Financial Market SupervisoryAuthority (FINMA) as group supervisor.During the setup phase in the first year after its establishment, EIOPAattended College meetings and/or teleconferences of 55 groups.The main conclusions from EIOPA’s observation in the Colleges in2011 are as follows:• Substantial efforts were made by supervisors in preparing, organisingand contributing to the College;• The exchange of the QIS5 and stress test results in most of the Collegesenhanced the quality of the discussions and improved the supervisors’common understanding of the undertakings’ risk exposure and solvencyposition;• Similarly, the discussion of financial conglomerate aspects, whererelevant, helped to improve College members’ awareness of the financialstrength of the groups as a whole;• Concerns or legal constraints in some Member States relating to theexchange of confidential information hampered the scope and quality ofdiscussions in the Colleges;• Differences observed between the Colleges regarding:- Scope, content and the frequency of information exchange in theColleges,- Preparation and focus of presentations and discussions with the firms’srepresentative are areas for improvement in implementing an EEA-wideconsistent, coherent and effective supervision for cross-border groups;• The emergency infrastructure test was successfully completed by mostof the Colleges; _________________________________________ Solvency ii Association www.solvency-ii-association.com
  44. 44. • The Colleges are making great efforts to prepare for theimplementation of the Solvency II Directive, in particular the pre-application process for use of an approved internal model.Participation in Colleges by EIOPA staffDuring 2011, five full-time equivalent staff were recruited to constituteEIOPA’s College team.A coordinator had been appointed at the beginning of 2011 to prepare astrategy for EIOPA and to kick off EIOPA’s participation in theColleges.EIOPA staff’s commitment to the Colleges focused primarily on thefollowing issues:• To explain EIOPA’s role in the Colleges;• To gain experience from participating in College meetings for the firstyear;• To monitor the collaboration of College members regarding theappropriate information exchange and the discussion of relevant topicsin the College;• To provide input into the agenda and stimulate information exchangewithin Colleges on stress test results and the dialogue on risk exposure,financial strength and resilience to adverse economic and financialmarket developments;• To provide regular updates on the working assumptions in light of thestill pending decisions on the Solvency II timelines;• To act as a link between the Colleges and Solvency II Working Groupsand provide practical input into Solvency II policy work. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  45. 45. During 2011, EIOPA staff observed overall significant differences in thelevel of information exchange.Areas for improvement include in particular a continuous and effectiveinformation exchange, as well as discussion and assessment of risks bytaking a more prospective view.EIOPA’s Action Plan 2012 for Colleges was established taking intoaccount the experience and conclusions from College work in 2011.Crisis ManagementIn early 2011, a set of interim procedures for dealing with emergencysituations was drawn up by EIOPA in conjunction with the other ESAs.A seconded national expert in crisis management was appointed inMarch 2011, and work then commenced on the development of apermanent framework for crisis management for EIOPA.Key to this was the development of a strategic policy on crisismanagement that was presented to the Board of Supervisors in June2011.The Board of Supervisors recognised the need to put a robust frameworkin place at an early stage, and an ad hoc Board of Supervisor’s task forcewas created to develop this framework.In December 2011, the task force delivered a comprehensive, decision-making framework which was endorsed by the Board of Supervisors.This framework sets out in detail the processes that EIOPA will follow indischarging its crisis pre-emption and management responsibilitiesunder the EIOPA Regulation.A small standing group was created, comprising EIOPA members andstaff, that will consider on a regular basis whether EIOPA needs to actunder the Regulation and what actions it may take. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  46. 46. This approach is seen as the most efficient way of carrying out regularmonitoring and preparing Board of Supervisors’ decisions on crisismanagement issues.EIOPA Work Programme 2012In 2012 EIOPA will already operate as a fully-fledged European agency,however many of the processes and procedures have to be refined oradapted to the growing organisation and new responsibilities.The Work Programme sets out the goals and deliverables for the secondyear of operations.Regulatory tasksIn 2012, EIOPA will deliver draft implementing and regulatory technicalstandards as well as guidelines in the different work streams, accordingto specific needs to complement the principles and regulations issued bythe European Commission.The concrete scope and timing of these deliverables depend on the finaldecision on the Omnibus II Directive (OMDII) as well as on theapproval of the final Delegated Acts implementing Solvency II.In 2012, EIOPA will prepare its final advice to the EuropeanCommission on the review of the Directive on the activities andsupervision of institutions for occupational retirement provision (IORPDirective).EIOPA will then develop specifications and carry out a targetedquantitative impact study (QIS) exercise in order to support theCommission’s proposal for a revised IORP Directive. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  47. 47. EIOPA will contribute to the revision of the Insurance MediationDirective (IMD), by providing a respective advice to the EuropeanCommission.Supervisory tasksEIOPA will continue to participate in the work of Colleges ofSupervisors and will specifically promote frequent information exchangeand discussion on risks.To promote the exchange of information in a safe and sound mannerwithin Colleges of Supervisors, EIOPA will give priority to its work onthe implementation of a common IT solution for the secure exchange ofinformation within Colleges, also in crisis times, with the aim to have thetool ready in 2012.In the course of 2012 EIOPA will launching three peer reviews on thefollowing topics: supervision of branches of EEA insurance entities,supervisory aspects of the pre-application of internal models andsupervisory powers to obtain information and intervention regardingIORPs.Consumer Protection and Financial InnovationEIOPA will further develop and pursue its leading role in promotingtransparency, simplicity and fairness in the market for consumerfinancial products and services across the internal market.This will be done by developing more standardised and comparableinformation about the risks and costs of products, relevant regulatoryrequirements and complaints handling procedures.The CCPFI will continue its monitoring and assessment of new orinnovative financial activities, release good practices reports and, wheredeemed appropriate, make proposals for the adoption of guidelines and _________________________________________ Solvency ii Association www.solvency-ii-association.com
  48. 48. recommendations with a view to promoting the safety and soundness ofmarkets and convergence of regulatory practice.Financial StabilityEIOPA will carry out a harmonised, pan-European stress test for theinsurance sector in cooperation with the ESRB, the ECB and EBA.In autumn 2012 EIOPA will deliver an annual assessment of sectordevelopments, highlighting implications for financial stability, with aprovisional report in the spring of 2012, outlining main market trendssince the end of 2011.The Authority will also further develop and monitor a risk dashboard incooperation with the ESRB and other ESAs.Crisis managementEIOPA will continue to develop its crisis management framework withthe focus on the pre-emption element and analytical tools to be used indecision- making.Later in 2012 a simulation exercise to test the operation of the newframework will be carried out.EIOPA will also contribute to the work of the European Commission indeveloping crisis management proposals for insurance, along with thework of the IAIS on resolution tools for systemically important insuranceundertakings.External RelationsEIOPA’s view is elaborated with the Members’ support and set forth inthe relevant committees of IAIS. Particular focus will be given to raiseEIOPA’s voice in the IAIS Executive Committee and to promote theCommon Framework for the Supervision of Internationally ActiveInsurance Groups (ComFrame). _________________________________________ Solvency ii Association www.solvency-ii-association.com
  49. 49. At the same time, EIOPA will continue to develop its internationalrelations by holding regulatory dialogues and maintaining a closecontact with third countries including the US, China, Japan and LatinAmerica.EIOPA will also continue to assist the European Commission inpreparing equivalence decisions pertaining to supervisory regimes inthird countries by way of producing final, fully consulted upon advice.Joint CommitteeIn 2012 the Joint Committee will furtherdevelop its work in the sub- committees onfinancial conglomerates, on cross sectordevelopments, risks and vulnerabilities on anti-money laundering and on consumer protectionand financial innovation.The exchange of information with the ESRBwill also be further developed. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  50. 50. List of the Members and Observers of the EIOPA Board ofSupervisors _________________________________________ Solvency ii Association www.solvency-ii-association.com
  51. 51. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  52. 52. Agathe Côté: Modelling risks to the financialsystemRemarks by Ms Agathe Côté, Deputy Governor ofthe Bank of Canada, to the Canadian Associationfor Business Economics, Kingston, Ontario, 21August 2012.***IntroductionIt has become a summer tradition for the Bank of Canada to address theCanadian Association for Business Economics.This year it is my pleasure and I thank you for the kind invitation.An audience of colleagues and fellow economists offers me anopportunity to delve into a complex subject, and one that is particularlytimely: financial system risk.We continue to see today the enormous costs to the global economy ofthe financial crisis that started five years ago.Of the many lessons we have learned from the crisis, a key one is this: weneed to pay more attention to the stability of the financial system as awhole.This means understanding better how risks get transmitted acrossfinancial institutions and markets, and understanding better thefeedback loop between the financial system and the real economy.From a policy perspective, this means taking a system-wide approach tofinancial regulation and supervision.Major reforms of the global financial system now under way address thisneed. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  53. 53. System-wide risk has been a focus of attention at the Bank of Canada,and at other central banks, for some time.Ten years ago, the Bank issued the first edition of its semi-annualFinancial System Review in which it identifies key sources of risks to theCanadian financial system and highlights the policies needed to addressthem.A year later, in 2003, we organized our annual conference on the themeof financial stability.In the wake of the global financial crisis, the Bank has intensified itsresearch efforts in this area.In particular, a priority is to improve the theoretical and empiricalmodels we use to analyze elements of the financial system that can leadto the emergence of risks and vulnerabilities.With more finely tuned quantitative models and tools, the Bank will bebetter able to identify risks on a timely basis so that the private sectorand policy-makers can take corrective action to support financialstability.Let me acknowledge upfront that this task is complex.While macroeconomic models have long been used to guide monetarypolicy decisions by central banks, models of financial stability andsystemic risk are much less advanced.In my remarks today, I want to talk about the progress that we havemade at the Bank in modelling risks to the financial system.I will start by briefly describing the notion of systemic risk and variousapproaches used to identify and measure it. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  54. 54. I will then discuss two state-of-the-art quantitative models that we havedeveloped to improve our assessment of risks to the Canadian financialsystem.The multiple dimensions of systemic riskSystemic, or system-wide, risk goes beyond individual institutions andmarkets.It is the risk that the financial system as a whole becomes impaired andthat the provision of key financial services breaks down, with potentiallyserious consequences for the real economy.Systemic risk manifests itself in different ways.There is a time dimension, which refers to the accumulation ofimbalances over time, and a cross-sectional dimension, which refers tohow risk is distributed throughout the financial system at a given pointin time.Procyclicality is the key issue in the time dimension.It reflects the tendency to take on excessive risk during economicupswings – too much punch from the punchbowl, if you will – and tobecome overly risk averse during the downturns.Procyclicality makes the financial system and the economy morevulnerable to shocks, and increases the likelihood of financial distress.Risk concentrations and interconnections are the key issues in the cross-sectional dimension.Financial institutions can have similar exposures to shocks or be linkedthrough balance sheets.As a result, losses in one institution can lead to fears of contagion that _________________________________________ Solvency ii Association www.solvency-ii-association.com
  55. 55. amplify the adverse effects of the initial shock.For instance, uncertainty about the viability of counterparties can lead tohoarding of liquidity, which may seem like an appropriate action for theindividual institution but can have disastrous consequences for thefinancial system as a whole.System-wide surveillance requires that we regularly assess theimportance of various types of systemic risk.How we judge a particular risk will be based on the probability that itwill lead to financial system distress, and on the extent of its impactshould that distress materialize.Early-warning indicatorsA fundamental challenge is to detect the risks arising from both globaland domestic sources in an environment with a vast number of potentialindicators.Therefore, one direction of research at the Bank has been to isolate thekey signals from this broad information set by identifying a smallergroup of variables that can serve as early-warning indicators of emergingimbalances.Since financial crises in Canada have been rare, international data areused to help establish numerical thresholds for each domestic indicator.For example, if international evidence suggests that credit growth abovea certain rate tends to be associated with increased risk, then a periodwith credit growth above the threshold would suggest an elevatedprobability of financial stress.Selecting the level of thresholds involves a difficult trade-off betweenfalse alarms and failure to signal an event, so in practice the early- _________________________________________ Solvency ii Association www.solvency-ii-association.com
  56. 56. warning indicators are used mainly to identify areas where more detailedinvestigation may be warranted.They provide an objective, practical starting point to detect the buildupof imbalances in the financial system.One early-warning indicator that we regularly track is the deviation ofthe aggregate private sector credit-to-GDP ratio from its trend (thecredit-to-GDP gap), which serves as a rough measure of excessiveleverage across the financial system (Chart 1).This indicator has been shown to provide some leading information as apredictor of banking crises, and has been proposed by the BaselCommittee on Banking Supervision (BCBS) as a useful guide fordecisions about when to activate the countercyclical capital buffer – animportant macroprudential policy instrument in the Basel III agreement.Given the complexity of systemic risk, it is unrealistic to expect a singlemeasure or indicator to serve all purposes. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  57. 57. Combining indicators can produce better signals with fewer false alarmsand undetected crises.For example, research shows that combining the Credit - to - GDP gapwith a measure of real estate prices produces an indicator that performsbetter than either variable on its own.Our own work at the Bank reinforces findings elsewhere that aggregateprivate sector credit and real estate prices are among the most reliableindicators of financial stress.Identifying sources of risk is essential, but so is determining thelikelihood that these risks will materialize.Therefore, another important aspect of ongoing research is thedevelopment of statistical models to help us forecast the probability thata crisis will occur based on a group of indicators.Macro stress testsEarly-warning indicators are useful to gauge the probability of financialstress, but a thorough assessment also requires an analysis of what couldhappen if the risk materializes.This is the goal of macro stress testing.A good part of the Bank’s efforts in recent years has been devoted todeveloping and refining stress-testing models.This class of models takes a large but plausible macroeconomic shock asa starting point and analyzes its impact on the balance sheets of banks orother sectors of the economy.The Bank now has two main stress-testing models to help monitor risksto the financial system. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  58. 58. These models can also be used to assess the potential impact of policytools or regulatory actions in mitigating financial system risks.Assessing risks from elevated household debtThe first, the Household Risk Assessment Model, or HRAM, is amicrosimulation model that assesses how the debt burden of Canadianhouseholds can affect financial stability.Using microdata from household balance sheets, the model allows us toestimate how various shocks would affect the distribution of debt withinthe household sector.The simulations take into account changes over time in individual debtlevels, as well as changes in household wealth from savings andfluctuations in the value of financial assets.Tracking the asset side of household balance sheets gives us a moreaccurate picture of systemic risk since changes in wealth affecthouseholds’ ability to pay their debt.Household vulnerabilities depend not only on the average level of debt,but also on how debt is distributed across individuals.One strength of the model is precisely its ability to account for thisdistribution.For instance, while record-low interest rates in recent years havecontributed to a relatively low aggregate household debt-service ratio,the share of Canadian households that are considered most vulnerable –those with a debt-service ratio equal to or higher than 40 per cent – hasclimbed to above-average levels, as has the proportion of debt held bythese vulnerable households (Chart 2). _________________________________________ Solvency ii Association www.solvency-ii-association.com
  59. 59. Using HRAM, we estimate that if interest rates were to rise to 4.25 percent by mid-2015, the share of highly indebted households would risefrom slightly above 6 per cent in 2011 to roughly 10 per cent by 2016,while the proportion of debt held by these households would rise from11.5 per cent to about 20 per cent over the same period.So while the aggregate household debt-service ratio paints a somewhatrosy picture, taking into account distributions gives us a clearer andmore cautionary indication of how vulnerable our financial systemactually is to household debt.Another strength of the model is that it provides a flexible tool forsimulating the impact on household solvency of a wide range ofpotential shocks, such as an increase in unemployment.HRAM indicates that household loans in arrears would more thandouble under a severe labour market shock similar to that observed inthe recession of the early 1990s. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  60. 60. Despite the model’s strengths, we continue to enhance our analysis byimproving HRAM.Expanding the behavioural aspects of the model is one way to do this.For instance, the model currently allows distressed households to paytheir debts by selling their liquid assets, but not their homes.Work is also under way to improve the design of the shock scenarios.Results of stress tests using HRAM are regularly reported in the Bank’sFinancial System Review and constitute an important element of ouroverall assessment of the risks associated with household finances.Assessing contagion effects in the banking systemHRAM provides invaluable information on vulnerabilities in thehousehold sector, but the Bank is also interested in assessing risks morebroadly within the Canadian financial system.To this end, we have been working for several years on developing aMacro Financial Risk Assessment Framework (or MFRAF).Drawing on detailed data from bank balance sheets, MFRAF is aquantitative model that tracks the contribution of individual banks tosystemic risk.Traditional stress-testing models focus exclusively on solvency risk, andestimate the overall risk to the financial system by simply aggregatingcredit (or other asset) losses that would materialize at individual banksin the event of a severe shock.MFRAF goes beyond this traditional approach by taking into accountlinkages among banks arising from counterparty exposures – or networkspillover effects – as well as funding liquidity risk, that is, the risk ofmarket-based runs on banks. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  61. 61. The financial crisis illustrated the significant risks associated with adeterioration of funding liquidity.The collective reactions of market participants led to mutuallyreinforcing solvency and liquidity problems at banks around the world.As funding liquidity evaporated, many well-capitalized institutions hadto take writedowns on illiquid assets, or sell them at a loss, creatinguncertainty in the market about their solvency and adding to thedownward pressure on asset prices.MFRAF has been built to integrate funding liquidity risk as anendogenous outcome of the interactions between solvency concerns andthe liquidity profiles of banks.This strong microeconomic foundation constitutes a major innovation inmacro stress-testing models.MFRAF also incorporates network externalities caused by the defaults ofcounterparties, with the size of a counterparty’s interbank exposuresincreasing the likelihood of spillover effects.A key lesson from the model is that failure to account for either fundingliquidity risk or interbank exposures could lead to significantunderestimation of the risks to the financial system as a whole if thebanking system is undercapitalized and relies extensively on theshort-term funding market.Importantly, the loss distributions generated by the model exhibitfat tails, a key feature of the actual distribution of financial system risks(Chart 3). _________________________________________ Solvency ii Association www.solvency-ii-association.com
  62. 62. The fact that the model is able to replicate this important stylized factdemonstrates that it has significant potential as a tool for assessingsystemic risk.Nevertheless, while MFRAF is already somewhat complex, the layers ofinteraction will need to be further augmented.For instance, the model misses any negative feedback that could occurbetween heightened risks to the banking system and the real economy.The model could also be expanded over time to include other types offinancial institutions and markets.Compared with other approaches that use market-based data, such asthe asset-pricing approach, the transmission channel in models likeMFRAF is transparent, and this improves our interpretation of results.Because of this “story-telling” ability, many central banks have begun touse this type of framework in their financial stability analysis. _________________________________________ Solvency ii Association www.solvency-ii-association.com
  63. 63. In addition to assessing risks, MFRAF can be used to examine themerits of policy or regulatory initiatives such as capital and liquidityrules.As the model becomes more refined, the objective is to use it more tocomplement other existing macro stress-testing exercises and to sharpenour analysis and communication of risks in the Bank’s Financial SystemReview.ConclusionLet me conclude.The Bank of Canada is conducting extensive research into findingmethodologies and tools to identify and measure systemic risk.While work in this area is extremely complex, the Bank has madesubstantial progress in recent years.We now have two state-of-the art models. And with HRAM, the Bank ofCanada is one of the few central banks at the leading edge of usingmicrosimulation models to assess vulnerabilities in the household sector.Our efforts to build these models have provided us with importantlessons.First, distributions matter – we cannot rely solely on aggregate data:distributional features and complex interactions are very important forassessing risks.This means developing models that capture these effects.Our household simulation model is aimed directly at understanding howthe distribution of debts, assets and income affects financial stability. _________________________________________ Solvency ii Association www.solvency-ii-association.com

×