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Solvency II survey 2011: Insurers' responses to evolving rules

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Solvency II Survey 2011: Insurers' responses to evolving rules is a Deloitte report, written by the Economist Intelligence Unit, which updates the EIU's 2010 research into insurers' preparedness for …

Solvency II Survey 2011: Insurers' responses to evolving rules is a Deloitte report, written by the Economist Intelligence Unit, which updates the EIU's 2010 research into insurers' preparedness for new European Union insurance regulation, known as Solvency II. The report examines key priorities, levels of knowledge about requirements and the current view of the potential impact of the regulation on individual businesses and the industry as a whole. The report was based on a survey of 60 UK-based insurers and an interview with the Association of British Insurers. The author was Gill Wadsworth and the editor was Monica Woodley.

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  • 1. Solvency II Survey 2011Insurers’ responses to evolving rules
  • 2. We are delighted to present this fourth annualDeloitte Solvency II Survey. Having beenimmersed in preparations for the Solvency IIregime for several years now, insurers are facedwith the continuing challenge of respondingto a mandatory change where the exact ‘rulesof the game’ are still evolving.This report has been produced on our behalf by the Economist Intelligence Unit basedon their findings from interviews during February 2011 with 60 insurers with UKoperations. Through their fully anonymous survey process, the Economist IntelligenceUnit is able to offer an impartial view of the true state of play for UK insurers and alsogive a flavour of the trends since the last survey.Survey information can provide organisations a useful checkpoint as preparationscontinue and offer a perspective on where they stand in relation to their peers.Significant progress has been made over the last 12 months and the survey identifiessome interesting developments and trends.The report’s findings highlight the far reaching consequences of Solvency II, includingthe number of companies looking at restructuring or relocating and the anticipatedconsumer impact as a result of changes in product mix, design and pricing.Implementation resource shortfall across the industry is a significant challenge andthere is a decline in confidence that the industry will complete the journey on time.We are very grateful to the EIU and to all participants for their contribution to thisresearch. I hope you find the Solvency II Survey 2011 useful – please do contact me ifyou would like to discuss any aspect of this report.Rick LesterSolvency II Lead Partnerrlester@deloitte.co.uk Solvency II Survey 2011 Insurers’ responses to evolving rules 1
  • 3. Introduction The European insurance industry has been immersed in In February this year, the chief executive of the Financial preparations for the Solvency II regime ever since the Services Authority (FSA), Hector Sants, acknowledged a adoption of the final text of the Directive in 2009. number of outstanding issues of the “utmost Yet much preparatory work remains to be done as importance” to the insurance industry regarding organisations, along with their local regulators, Solvency II and noted that further debate and analysis continue to wait for the regulatory requirements for were still needed to address ongoing anxieties. implementation to be finalised. While the final deadline for compliance is moving from November 2012 to However, as the window of opportunity to shape the 1 January 2013 there is uncertainty as to how the final regulations gradually closes and insurers are transitional arrangements will be applied in practice. expected to work within the new regime, how ready is the industry for implementation and what are the The European Insurance and Occupational Pensions causes of greatest concern? Committee (EIOPC) and the European Commission are currently scrutinising level two implementing measures Following on from research in 2010, the Economist (which will specify how the Directive’s principles must Intelligence Unit, commissioned by Deloitte, again be applied in practice). The outcome of this is dependent surveyed a sample of 60 UK-based insurers to ascertain upon the EIOPC’s simultaneous review of the Omnibus their latest views on Solvency II and reassess their II Directive to bring Solvency II into line with the Lisbon readiness for the new regime. Respondents covered all treaty, which will come into force in the fourth quarter types of business from smaller, stand-alone of 2011. The European Insurance and Occupational organisations to large groups. Pensions Authority (EIOPA) will also be developing level three text until the end of this year and will approve the Respondents were grouped by size with the very largest final guidelines after a period of consultation in the first insurers reporting more than £5bn in net written quarter of 2012. premiums (NWP); large insurers with between £1bn and £5bn NWP; those with £500m to £1bn; £300m to £500m; £100m to £300m; and less than £100m NWP. Thirty respondents were life companies, 28 were non- life and two were composite. Figure 1. In which region is your head office domiciled? Figure 2. Where does your group operate? % 4% 5% 80 5% 70 60 50 40 30 20 86% 10 0 UK Australasia Other Europe UK Other North Middle Latin Asia Europe America East/ America North America Africa2
  • 4. Heightened awarenessNinety-five percent of respondents’ boards were fully Figure 3. What approximate percentage of the FTE resource required for your Solvency II programme has been put in place?aware of and engaged in the regulatory responsibilities %and opportunities arising from Solvency II, a rise from83% in last year’s survey. Only the very smallest insurers 40were yet to brief their boards on the potential 35implications of the new regime, while one non-life 30insurer with between £100m and £300m admitted thatits board had no knowledge of Solvency II at all. 25 20This lack of awareness was atypical, however, withmost insurers taking positive action in preparation for 15the regime. Ninety percent of all respondents and 10100% of insurers with over £500m NWP had 5completed a gap analysis, while two-thirds of thosesurveyed had made the business case for Solvency II. 0 0% 20% 40% 60% 80% 100% 2010 2011Ulrich Zink, policy adviser at the Association of BritishInsurers (ABI), says: “Solvency II is clearly a top priorityfor the boards of insurers in the UK. Whether this Figure 4. What training programme do you have in place for Solvency II?awareness is being driven by the regulator or internally,you can be certain every board in the UK is aware of %Solvency II and is acting on it.” 50More than half (52%) of all respondents had reached 40the implementation stage including 75% of the verylargest insurers (with over £5bn NWP). Reflecting this 30level of advancement, 60% of respondents have at least60% of their complement of full time Solvency II 20employees already embedded. However, the remaining40% have 40% or less of their dedicated Solvency IIpersonnel in place, with as many as seven (12%) 10insurers having only embedded 20%. Trainingprogrammes are scheduled at 58 of the 60 insurers 0surveyed, with half of the respondents offering general A combination Tailored General General No structured Tailored of general training training for all training programme training fortraining for all employees and tailored training for key training for for some for some all impactedpersonnel. all and tailored by Solvency II training for some Solvency II Survey 2011 Insurers’ responses to evolving rules 3
  • 5. Future focusFigure 5. Which of the following areas will your organisation be focusing on most in the In spite of the ongoing uncertainty over the finalnext six months? (Respondents were asked to select and rank five) demands from Solvency II, insurers are pressing ahead with their preparations for the new regime. The focus Implementation planning 1 of attention remains the same as last year and relates Personal incentivisation and reward =2 to preparations for securing approval for new internal Risk governance system =2 models. Given that 80% of respondents plan to implement a full internal (50%) or partial internal Data infrastructure and data handling processes 3 (30%) model under Solvency II, issues such as data Culture 4 infrastructure and data handling were listed as top-five Risk appetite =5 priorities for the next six months, particularly among Data quality =5 large insurers. Similarly, implementing risk governance Performance measurement 6 also tops the agenda for the first half of 2011. Documentation =7 While the EIOPA is yet to publish guidance on internal Embedding and use =7 models, which will be laid out in the commission’s level-two measures expected in June this year and EIOPA’s level-three requirements due in December, insurers were still focusing on internal model design Deloitte comment – Richard Hurley and implementation, as well as the internal model Technology implementation issues are now becoming real. The designs that approval process (IMAP) itself. have been developed are being handed over to the IT development teams and delivery plans are being developed. These plans are now showing that Respondents to the survey were confident they would either timescales are going to have to move or scope is going to have to be meet the deadlines in this area with most insurers reduced. (88%) expecting to have entered the IMAP by the fourth quarter of 2011, one in 10 by the first quarter In addition, although in many cases the architectures are simple, applications of 2012, while just one insurer (with NWP greater than are being pushed beyond their original design specifications, either from £1bn) admitted it would be later. a functionality or performance point of view. This complexity is being added to by the need to undertake complex integrations with legacy systems. In last year’s survey, one-third of respondents said they For these reasons, many insurers are looking at how they can implement in would lobby the regulator and industry bodies for a phased way and/or looking at using prototypes during the first phase of support in dealing with the IMAP. Subsequently the ABI their implementations. has produced guidance for insurers, endorsed by the FSA. The document, released in February, suggested Data remains a key area of concern, be it the accessibility or granularity of large insurers have their work plan in place by the end data, and in many cases its quality. Therefore many organisations are now of March this year in order to reduce the burden on looking at how they can simplify their data requirements in order to achieve both their own organisation and that of the regulator in a realistic solution. the run-up to final implementation of Solvency II. Finally, the scale of the testing requirement is coming into focus. The overall approaches to system integration and user acceptance testing are being developed. These critical activities are putting pressure on overall timescales.4
  • 6. RepercussionsUnderstandably, respondents to the survey recognise Deloitte comment – Stephen Rossthat implementing such a regulatory overhaul will have As the implementation date for Solvency II approaches and board levelfar-reaching implications for their businesses. Nearly half awareness of its impact increases, it is apparent that insurers are beginning(47%) will have to reorganise or restructure as a result to appreciate the real implications it will have for their business. It is veryof Solvency II, with the highest instances among life clear from the Survey and from our client conversations that Solvency II isinsurers with between £1bn and £5bn NWP (71%). acting as a catalyst for businesses to restructure. For many businesses theMuch of the restructuring will arise from insurers driver for this has been to maximise capital fungibility and thus to be ablerecognising more efficient means of managing capital to allocate capital effectively across the group. This means that manyvia branch rather than subsidiary structures. businesses are transitioning from subsidiary structures (where capital is trapped in individual entities) into ones with branch structures where capitalWhile there may be opportunities to take elements of is more fungible across the group.the business outside of the EU, relocation remains Another possible implication of Solvency II is the potential for M&A. Weunlikely for most insurers, with just 8% of respondents expect that as the financial metrics associated with Solvency II becomesaying they would move their business headquarters, clearer, insurers will consider the options to drive towards the ideal businessas the tax implications of moving to new territories may mix whilst being aligned to their overall strategy. This is likely to lead topreclude any benefits from side-stepping Solvency II. M&A activity in the form of acquisitions or disposals of portfolios, teams orHowever, one of the four largest insurers responding to companies as businesses look to achieve the scale and diversity they see asthe survey is considering relocating. optimal under the new regime.Figure 6. As a result of Solvency II, do you envisage yourorganisation will need to do any of the below? Life insurers were more likely than their non-life counterparts to make changes to their product mix,% as capital requirements under Solvency II have a much50 greater impact on the types of long-term guaranteed products offered by life companies. One in five life insurers said they envisage changing their product mix40 and redesigning products, compared with fewer than one in 10 non-life companies, while one-third of life30 companies and one in 10 non-life companies identified opportunities to launch new products under20 the new regime. Mr Zink says: “Life insurers are selling long-term10 guarantee products and those attract heavy charges [under Solvency II]. These are crucial products as many 0 people rely on them for their retirement. If the Reorganisation/ Relocation Not decided requirements remain as they currently are, firms will Restructuring have no option but to either significantly increase premiums or to reduce their offering, shifting towards 2010 2011 products where the risk remains with the policyholder. Both scenarios will be to the detriment of the consumer for whom it is important to have good access to aAs the transparency requirements of Solvency II make it range of appropriate products and propositions.”easier for insurers to identify which product lines aremost profitable and which are most capital-intensive, Given that a key motivation for introducing Solvency II isbusinesses will be well-placed to streamline their better appreciation and management of risk within theofferings, removing those which have the least to offer. European insurance industry, it comes as no surprise thatOne in five organisations claim they will need to re-price two-thirds of all respondents will introduce new risk-their products, with the largest and smallest insurers mitigation techniques. While an equal number of life andmost affected. Thirty-five percent of those with less non-life companies said they would take this step, neither of the composite respondents had plans to do so.than £100m in NWP and 75% of businesses with morethan £5bn in NWP expect to re-price. Solvency II Survey 2011 Insurers’ responses to evolving rules 5
  • 7. Aligning interest Not content with introducing Solvency II, European “We have had some success in dealing with legislators are also focusing on international and other discrepancies between Solvency II and IFRS; we lobbied financial reporting standards. Opportunities for insurers to align the two and we are moving towards that. It is to align these differing demands are hampered by a not helpful for different legislation to have several lack not only of clarity but also of coherence. According definitions for similar terms, which creates confusion to the survey, interdependency with other change and duplication of effort. We will continue to lobby in programmes is a top-three concern for businesses in this area,” he says. implementing Solvency II. Deloitte comment – Francesco Nagari Figure 7. Do you plan to have a single integrated programme that will both implement Solvency II and manage the When the Solvency II draft Directive was first transition to IFRS 4 Phase II? published in July 2007, the International Accounting Standard Board (IASB) had also published its preliminary views on the future IFRS 18% for insurance (IFRS 4 Phase II Discussion Paper). At that point there was strong alignment 43% between the two bases, both aiming at a market consistent valuation of insurance portfolios with day one profit recognised in IFRS financial statements. The industry has lobbied the IASB to 38% abandon that approach, deemed too volatile, in favour of a valuation that defers profit on day one (residual margin liability) and recognises it later based on the insurer’s own estimates. Yes No Not decided Note: Figures do not add to 100% due to rounding Although the underlying building blocks of the valuation bases remain notionally the same (present value of expected cash flows and a risk margin liability) their detailed calculation is still Fewer than half (43%) of respondents said they would apart in a number of areas, requiring careful take a single, integrated approach to implementing assessment of Solvency II implementation Solvency II and managing the transition to IFRS 4 Phase decisions that may prove costly when IFRS 4 II. About two-thirds (64%) of the largest insurers said Phase II is implemented. The IASB expects to they would not try to integrate their response to the approve the final IFRS 4 Phase II text in July changes. 2011 with mandatory application from 2014 at the earliest, subject to EU endorsement. However, two thirds of respondents do plan to align the reporting close processes of Solvency II with IFRS On the positive side, the draft level 2 rules and a little over a third with MCEV. appear to give insurers capital credit for the residual margin liability but require detailed Mr Zink says the ABI has been lobbying strongly for reconciliations between the two bases to be better alignment of the various pieces of European published on a regular basis to the market legislation and encourages insurers to take an and regulators. integrated approach where possible.6
  • 8. Counting the costIn his February speech addressing issues facing the Deloitte comment – Rick Lesterindustry as it grapples with Solvency II, the FSA’s Accurate budgeting for Solvency II has been an ongoing challenge forMr Sants recognised the significant cost burden the insurers, regardless of when they began the planning process. In part this haslegislation imposes. Not only do insurers face their own been driven by the unique scale of change Solvency II requires, but also theinternal cost demands but the FSA will recover an lack of clarity around the final requirements, which remains a top concern forestimated £100m from the industry as a direct result of respondents.imposing Solvency II. Mr Sants claims the regulator will“continue to work to minimise these costs” but the ABI The full cost implications of any large scale change programme are rarelydescribed the expense of Solvency II as “spiralling transparent or easily quantifiable in advance. This is highlighted in the data,upwards and out of control” and the issue still looms as 12% of all respondents and 36% of larger insurers are still undecided onlarge for respondents to the survey. their total budget.Insurers with £500m to £1bn in NWP ranked cost as This lack of a final decision on overall budget, even at this late stage, maytheir biggest concern in implementing the Directive, highlight that these insurers are struggling to quantify the full costwhile all other insurers ranked it as at least a implications of their programme.top-three worry.While two-fifths of insurers responding to the surveysaid their budgets were fully signed off until the end of Where costs were decided, 20% of respondents expectnext year, one in 10 insurers had not finalised their total to spend less than £1m on Solvency II. Insurers withSolvency II cost while just over half (52%) had only NWP below £500m typically expected to spend lesspartial budgetary approval. More non-life insurers (50%) than £5m. While no insurer in our survey expects to paythan life (30%) have had full budgetary approval. over £100m on implementation, 36% of insurers with over £1bn in NWP are still undecided on their total budget. Those larger insurers who have decidedFigure 8. Which of the following best represents the stage anticipate spending anywhere between £1m and £75m.of your overall Solvency II budget (to 2012) in the approval Life and non-life companies had very similar costprocess? expectations, with the majority expecting to pay less 7% than £10m. Figure 9. Which of the following best represents your total budget for Solvency II (including technology spend), approved or otherwise? 52% 0% 41% 2% 12% 3% 20% 0% 3% Budget signed off for part of Solvency II implementation Complete budget signed off to the end of 2012 27% Budget submitted, awaiting approval 33% £0 – £1m £1 – £5m £5 – £10m £10 – £25m £25 – £50m £50 – £75m £75 – £100m £100m+ Not decided Solvency II Survey 2011 Insurers’ responses to evolving rules 7
  • 9. Commenting on the drivers of cost Mr Zink said: Unsurprisingly the largest insurers said they would need “A massive expense lies in the IT upgrade. Obviously it the highest amount of full-time employees to deal with depends on where you start from and how developed the new legislative demands, with a quarter of those the company is internally which determines how much with NWP over £5bn and 16% of those with NWP of an upgrade you need.” between £1bn and £5bn expecting to dedicate more than 100 personnel to implementing Solvency II.Figure 10. How many FTE (Full Time Employees) do you predict to be involved in delivery On average, insurers said they needed fewer thanof your Solvency II programme at any one time over the course of 2011? 20 full-time employees and that a third of Solvency II% preparations and implementation would be undertaken60 by contractors.50 All respondents have at least 20% of the full-time staff required already in place. More than one in 10 (12%)40 reported that all the requisite full-time staff had been appointed, two thirds of which are the smaller insurers,30 although this is most likely because they have a smaller number of positions to fill.2010 0 0 to 10 10 to 20 20 to 50 50 to 100 100 plus 2010 20118
  • 10. The right modelWhile all respondents have now decided on whether When it comes to choice of capital aggregationthey will apply for use of a full internal model or partial techniques, there are a number of methods availableinternal model or stick with the standard formula, a but nearly one third of all respondents have not chosenthird of respondents have yet to decide whether they a model at this stage. Of those insurers which haveneed to use proxy methodologies such as curve fitting decided, almost half will be using a simulation-basedor replicating portfolios to speed up their liability approach, with 38% opting for ‘Monte Carlo with inputcalculations. Almost a third of companies will be using copula’ and 9% choosing ‘Monte Carlo with outputcurve fitting, while the replicating portfolio approach copula’ (9%). The remaining 23% will be using Riskproved the least popular as a sole choice for all insurers. Geographies or other variance/co-variance techniques.In fact none of the largest insurers and just one lifeinsurer will use this option alone. Over a third ofinsurers said they will use both approaches. Figure 11. Do you plan to undertake a curve fitting or replicating portfolio approach to speed up calculation run-times? 5% Deloitte comment – Roger Simler Companies have spent a large amount of time 35% considering improvements to the capital 29% aggregation techniques typically used as part of internal capital assessment (ICA), with the need to consider non linearity and tail dependency precluding the so called ‘medium bang’ approach for most companies. The variety of approaches being taken is indicative of this being a developing area. While the early movers 31% have mainly chosen to use a simulation based approach (Monte Carlo with input/output Both Not decided Curve fitting copulas), those who perhaps started later are Replicating portfolio increasingly looking to less technologically intensive methodologies such as Risk Geographies. Whatever method is chosen, Figure 12. What is your approach to Economic Capital Aggregation? most companies will be using some form of % proxy modelling technique to speed up the 40 calculations required from their liability projection models. This tends to be a relatively 35 complex area, and companies that have not yet 30 determined how best to speed up their calculation would be well advised to press on 25 with this activity. 20 15 An area that is often overlooked is the approach that companies will take to the calibration of 10 their models, with scarcity of data in the tails 5 being one of the factors that should be 0 considered when choosing the aggregation Input Copulas Not decided Variance/ Output Copulas Risk approach. with Monte Co-Variance with Monte Geographies Carlo simulation Carlo simulation Solvency II Survey 2011 Insurers’ responses to evolving rules 9
  • 11. Confidence in compliance There was a drop in confidence that the insurance “Another element to take into account is whether industry would meet the compliance deadline from last EIOPA and local regulators are willing to be flexible. year’s survey with fewer than half of respondents (46%) The ABI still supports the implementation of Solvency II confident or very confident, compared with 63% last by 1 January 2013 but in our view the current schedule year. Greatest confidence in compliance was exhibited is on the edge of what is practically achievable, in by the largest insurers, while organisations with NWP particular with regard to the Internal Model Application between £300m and £1bn demonstrated the least Process. Some specific provision will have to be amount of faith that the industry would hit the final introduced for companies participating in the first wave deadline. However, respondents showed greater levels of internal model approval for firms to stand a chance of optimism about their own organisations, with nearly to have more than a handful of models approved by three-quarters (73%) saying they were either confident [the deadline],” he says. or very confident they would hit the deadline. The European Commission has, so far, been pragmatic Mr Zink says insurers are willing to do all they can to in its approach to imposing deadlines and has shown its meet the deadline and are dedicating all the requisite willingness to delay implementation dates by moving resources to the project. However, he adds that much the initial November deadline to January 2013. of their confidence lies in expectations of flexibility from the regulator. Figure 13. How confident are you that the insurance industry as a whole will be able to achieve compliance with Solvency II by the end of 2012? % 60 50 40 30 20 10 0 Very Confident Still waiting Concerned Very Not sure confident to make up concerned my mind 2010 201110
  • 12. ConclusionClarification from the regulators remains a top concern Figure 14. Which of the following areas are you most concerned about for your business in implementing Solvency II? (Respondents were asked to select and rank three)for survey respondents and, as insurers attempt toprepare for the new regime, the persistent lack of Sponsorship and engagement 1direction continues to throw countless obstacles in theirpath. With one in 10 respondents claiming to be very Clarification and guidance from the FSA/ECC/EIOPA 2concerned that the industry will achieve compliance, Interdependencies with other change programmes =3the EIOPA is under pressure to provide more support to Resource =3European insurers. Cost 4 Internal model approval process =5However, the consultative approach taken means theindustry has been given a voice in shaping Solvency II, Programme structure, governance and delivery =5and insurers must accept this will likely delay the EIOPA Change of regulatory requirements =5in issuing regulatory guidance. Parallel run requirements 6 Timescales 7Insurers must continue to work with the EIOPA andlocal regulators to mould the new regime and, as they Consistency of approach across Europe 8await greater clarity, endeavour to prepare theirorganisations as effectively as is possible forimplementation. Solvency II Survey 2011 Insurers’ responses to evolving rules 11
  • 13. Deloitte contacts Rick Lester Francesco Nagari Solvency II Lead Partner Global IFRS Insurance Lead Partner 020 7303 2927 020 7303 8375 rlester@deloitte.co.uk fnagari@deloitte.co.uk Richard Hurley Roger Simler Partner, Technology Consulting Partner, Actuarial & Insurance Solutions 020 7303 8912 020 7303 3292 rhurley@deloitte.co.uk rsimler@deloitte.co.uk Stephen Ross Partner, Corporate Finance 020 7303 2185 steross@deloitte.co.uk12
  • 14. Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited (“DTTL”), a UK private company limited by guarantee, andits network of member firms, each of which is a legally separate and independent entity. Please see www.deloitte.co.uk/aboutfor a detailed description of the legal structure of DTTL and its member firms.Deloitte LLP is the United Kingdom member firm of DTTL.This publication has been written in general terms and therefore cannot be relied on to cover specific situations; application of theprinciples set out will depend upon the particular circumstances involved and we recommend that you obtain professional advicebefore acting or refraining from acting on any of the contents of this publication. Deloitte LLP would be pleased to advise readerson how to apply the principles set out in this publication to their specific circumstances. Deloitte LLP accepts no duty of care orliability for any loss occasioned to any person acting or refraining from action as a result of any material in this publication.© 2011 Deloitte LLP. All rights reserved.Deloitte LLP is a limited liability partnership registered in England and Wales with registered number OC303675 and its registeredoffice at 2 New Street Square, London EC4A 3BZ, United Kingdom. Tel: +44 (0) 20 7936 3000 Fax: +44 (0) 20 7583 1198.Designed and produced by The Creative Studio at Deloitte, London. 10531AMember of Deloitte Touche Tohmatsu Limited

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