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  • 1. SOLVENCY 2 An Introduction By John Brady 12/07/10 Don’t forget the risk analysis
  • 2. Solvency 2
    • To protect the interests of policy holders or beneficiaries by ensuring the financial stability of insurance and reinsurance undertakings within the European Union
    04/01/11
  • 3. Solvency 2 (2009/138/EC)
    • Signed by the Council of European Union
    • Signed by the European Parliament
    • Signed on 25 th November 2009
    • Publishd in the Official Journal on the 17 th December 2009
    • Implementation due by 31 st October 2012
    04/01/11
  • 4. Solvency 2 - Ireland
    • There are two elements relevant in Ireland
      • The Solvency 2 Directive (2009/138/EC)
      • Financial Regulator - Consultation Paper 41 (CP41)
    04/01/11
  • 5. Solvency 2 Pillars
    • Solvency two is based on three pillars:
      • Pillar One - Adequacy of Financial Resources
      • Pillar Two – Effective Governance
      • Pillar Three – Disclosure Requirements
    04/01/11
  • 6. Pillar One
    • Pillar One sets out the quantitative requirements that undertakings must satify to demonstrate they have sufficient capital resources.
    04/01/11
  • 7. Balance Sheet Equation 04/01/11 Free Surplus Assets Solvency Capital Requirement (SCR) Minimum Capital Requirement (MCR) Technical Provision Other Liabilities
  • 8. Pillar One
    • Under pillar 1 undertakings must maintain:
      • Technical provisions in respect of all obligations
      • A minimum capital requirement [MCR]
      • A higher solvency capital requirement [SCR]
    • These requirements must be covered by the undertakings own funds [Regulatory Capital]
    04/01/11
  • 9. Technical Provisions
    • All undertakings must
        • Establish technical provisions with respect to policy holders and beneficiaries.
          • Value of technical provision should correspond to value of obligation (if transferred to another undertaking).
        • There are two elements to the technical provision
          • A best estimate – the best estimate should take account of the time value of money
          • A risk margin –
            • this is on top of the best estimate and is based on the value if there is an immediate transfer to another undertaking
            • This is calculated by determining the cost of providing eligible own funds equal to the SCR necessary to support the undertakings insurance obligations over their lifetime.
    04/01/11
  • 10. Solvency Capital Requirement [SCR]
    • “The economic capital to be held by an undertaking in order to ensure that ruin occurs no more than once in 200 cases”
    • The SCR corresponds to the Value at risk of the basic own funds of an undertaking subject to a confidence level of 99.5% over a one year holding
    • The SCR can be calculated based
      • on the standard formula as set out in the directive
      • an internal model, subject to Financial Regulator approval.
    04/01/11
  • 11. Solvency Capital Requirement [SCR]
    • The Solvency Capital Requirement are in relation to
      • All existing business
      • Expected new business for the next 12 months
    • The Solvency Capital Requirement covers
      • Non Life underwriting risk
      • Life underwriting risk
      • Health underwriting risk
      • Market risk
      • Credit risk
      • Operational risk
    04/01/11
  • 12. Minimum Capital Requirement 1 [MCR]
    • The Minimum Capital Requirement is
      • A capital value which triggers regulatory intervention
      • The amount below which the amount of financial resources should not fall
      • It must be calculated quarterly
      • A report showing the results must be submitted to the Financial Regulator
      • The results cannot be less than 25% of the SCR or greater than 45% of the SCR.
    04/01/11
  • 13. Minimum Capital Requirement 2 [ MCR]
    • If the value slips below the minimum capital requirement:
      • The authorisation of a firm is withdrawn unless the minimun capital can be achieved in a short period of time.
    04/01/11
  • 14. Pillar Two
    • System of Governance
    • Own risk and Solvency Assessment
    • Oversight and Control Functions
    • Outsourcing
    • Supervisory Review Process
    04/01/11
  • 15. System of Governance 1 Article 41
    • An effective system of governance to ensure sound and prudent management of the business proportionate to the nature, scale and complexity of the undertaking
    • The system of governance must be subject to review
    04/01/11
  • 16. System of Governance 2
    • The system of governance must include
        • An adequate and transparent organisational structure
        • Clear allocation and segregation of duties
        • An effective system for transmission of information
        • Documented Policies and Procedures which must be reviewed at least annually or more often if there are any material changes
    04/01/11
  • 17. Documented Policies and Procedures
        • Documented Policies and Procedures which must be reviewed at least annually or more often if there are any material changes
        • Policies must at least cover
          • Risk management
          • Internal control
          • Internal auditing
          • Outsourcing
        • Documented Policies and Procedures are subject to prior approval by the Financial regulator (Article 41.3)
    04/01/11
  • 18. Own risk and Solvency Assessment (ORSA)
    • All undertakings must
      • Assess overall solvency needs with a view to their risk profile
      • Complete a regular review
      • Identify any deviations form the assumptions underlying the regulatory capital calculation
      • Be specific to the undertakings risk profile – dependent on the complexity of the undertaking
      • Provide the result to the Financial Regulator
      • If an internal model is used for the calculation of the SCR, the result can be used for the ORSA.
    04/01/11
  • 19. Oversight and Control Functions Internal Control System (Article 46)
    • Undertakings are required to have internal controls which include:
        • An internal control framework
        • Compliance function
        • Administration procedures
        • Accounting procedures
        • Reporting process
    • The compliance function is responsible for all aspects of compliance including laws, regulations, directives and any other industry rules.
    04/01/11
  • 20. Oversight and Control Functions Internal Audit Function (Article 47)
    • All undertakings must have an internal audit function which is responsible for evaluating :
      • the adequacy of the internal control system
      • the effectiveness of the internal control system
      • Evaluating any other elements of the governance system
    04/01/11
  • 21. Oversight and Control Functions Actuarial Function (Article 48)
    • All undertakings must have an actuarial function which is responsible for:
      • Assessing the adequacy of the methodology and model used to calcualte the technical provision
      • Co-ordinating and overseeing the calcualtion of the technical provision
      • Assess the adequacy of the data used and any assumptions in the calculation of the technical provision
      • Expressing opinions on the underwriting policies and reinsurance arrangements
      • Support the effective implementation of the risk management system - particularly in relation to the ORSA
    04/01/11
  • 22. Outsourcing
    • Solvency 2 permits outsourcing but full responsibility remains with the undertaking.
    • The FR must be informed
      • prior to outsourcing of any critical or important function
      • Of any material developments in relation to these outsourced functions
    • The undertaking must
      • review and monitor the outsourcer
      • Document the review to a standard acceptable to the FR
    04/01/11
  • 23. Supervisory Review Process 1 (SRP)
    • The Financial Regulator will regularly review and evaluate the
      • The quantitative and qualitative compliance of the undertaking in relation to its operating environment
      • Current and potential risks
    04/01/11
  • 24. Supervisory Review Process 2
    • The review will consider
      • System of governance and risk assessment
      • Technical provisions
      • Capital requirements
      • Investment rules
      • Quality and quantity of own funds
      • Use of full or partial internal model
    • Following the review the FR can require an undertaking to remedy any discovered weakness or deficiency. Under Article 37 a Capital Add On can be imposed if the undertaking has deviated from it underlying assumptions.
    04/01/11
  • 25. Financial Regulator Consultation Paper 41 (CP41)
    • Published by Financial Regulartor on 27 th April 2010
    • Sets the minimum requirements for credit institutions and insurance undertakings (life and non life )
        • Membership of boards
        • Role of the chairman
        • Operation of board committees
    04/01/11
  • 26. Pillar 3 Disclosures
    • An annual report on solvency and financial condition
    • The report must include:
      • A description of the business and the undertakings performance
      • A discription of the governance system and an assessment of its adequacy for the risk profile of the undertaking
      • A risk assessment for each category of risk – risk exposure, concentration, mitigation and sensitiviy
      • A description for each asset, technical provision , other liabilities with bases and methods of valuation
      • A description of the capital management
    04/01/11 © John Brady 2010
  • 27. Disclosures
    • Capital Management disclosures must include
      • The structure and amount of own funds, and their quantity
      • The amount of the MCR
      • The amount of the SCR and the option used to calculate it
      • Information which allows for an understanding of the main differences between the underlying assumptions of the standard formula and those of any internal model used in calculating the SCR
      • The amount of any non compliance with the MCR with explanations and consequences as well as remedial action taken.
      • The amount of any significant non compliance with the SCR with explanations and consequences as well as remedial action taken.
    04/01/11
  • 28. Implementation of Solvency 2
    • The Financial regulator has set out four steps to implementation
      • Implement an appropriate governance framework
      • Appoint an execute with responsibility for overseeing the implementation (the Financial regulator recommends there should be a specific Board member responsible)
      • Performa gap analysis to identify shortfalls
      • Implementation should focus on all three Pillars
    • The Financial Regulators needs to be informed of the Person appointed and if the undertaking intends to use an internal model
    04/01/11