The document discusses the latest developments regarding Solvency II Pillar 1, highlighting key implications from the European Parliament's report on the omnibus II directive, including changes to risk-free rates, illiquidity premiums, and various adjustments for health underwriting risks. Key topics include new capital requirements for counterparty default risk, symmetric adjustment mechanisms for spread risk, and eligibility criteria for matching adjustments in life insurance obligations. Additionally, it outlines transitional measures for third country equivalence and reviews to be conducted post-implementation of Solvency II.

1. Solvency II
Pillar 1 Latest Developments
Presented by: Edward Maguire
Date: 23rd May 2012

2. Agenda
• European Parliament report for the Omnibus II Directive
• Summary of Implications from a Pillar 1 perspective
Followed by Focus on
– Risk Free Rates
– Adapted Risk Free Rates (Illiquidity Premium)
– Spread Risk Submodule
– Matching Adjustment
– Health Underwriting Risk Submodule
– Equivalence
– Post Implementation Review
– Other developments

3. European Parliament report for Omnibus II
• Published by Economic and Monetary Affairs Committee (ECON)
• Report Rapporteur: Burkhard Balz MEP
• Tabled and Passed by Parliament 28th March 2012
• Implications for Pillar 1
especially in relation to discounting

4. Implications for Pillar 1
• EIOPA to be granted responsibility for drafting regulatory technical standards
covering all aspects of Pillar 1
• Zero risk treatment for Government bonds no longer reflects economic reality
– New recital to require report from Commission on allowance for such
exposures within capital requirements, bearing in mind any potential
destabilising effects this may have during stressed markets
• Changes to MCR Floor, introducing consistency between reinsurers and insurers
• Counterparty default risk: OTC derivatives not cleared centrally subject to higher
capital requirements than those cleared through central counterparty

5. Implications for Pillar 1
Continued
• Various proposals on discount rates including
– Approach for Risk Free Rates including extrapolation
– Illiquidity premium - adapted risk free rates
– Spread Risk Submodule: Symmetric Adjustment Mechanism extended to fixed
interest securities
– Matching Adjustment (Matching Premium)
• SCR for Health should reflect national equalisation systems and changes in
national health legislation
• Equivalence requirements for third countries and transitional measures

6. Risk Free Rates
• EIOPA to publish risk free rates by currency on at least a monthly
basis
• Extrapolation of risk free rates
New Recital and Article to propose
– Extrapolation of risk free rates beyond time by which relevant markets
are no longer considered to be deep, liquid and transparent
– Extrapolation under current markets for Euro curve to start after 20
years
– Converging to ultimate forward rate for maturities 10 years beyond
point where markets no longer considered deep liquid and
transparent
– Extrapolated rates at this point to be within 3 bps of ultimate forward
rates

7. Illiquidity premium
• Illiquidity premium – adapted risk free rates
• EIOPA, in co-operation with ESRB, to publish adapted risk free
rates with illiquidity premia by currency
– On demonstration of temporary and exceptional stressed financial
markets for a given currency
– The adaptation shall be calculated with reference to a portion of the
spread between the interest rate that could be earned from assets
included in a representative portfolio of assets and the rates of the
basic risk-free interest rate term structure
– Applies to certain illiquid liabilities matching criteria
– Subject to requirement that the use and impact of any illiquidity
premium spreads to be disclosed by undertakings

8. Spread Risk Submodule
•Symmetric Adjustment Mechanism
• Proposed inclusion of symmetric adjustment mechanism within
standard formula spread risk sub-module
– To cover the risk arising from changes in the level of bond prices and prices of
other fixed income securities with similar cash-flow characteristics.
– Mirroring the mechanism under the equity risk sub-module
– Based on current level of appropriate fixed income index relative to weighted
average level of that index
– Impact limited to maximum of 25% change in unadjusted spread risk capital
– Insurance and reinsurance undertakings applying the illiquidity premium
shall not apply the symmetric adjustment in the event the result of the
adjustment is a spread capital requirement lower than the standard spread
capital requirement

9. Matching Adjustment
•Matching Adjustment (Matching Premium)
New article proposed for certain life insurance obligations
– Member states can approve for individual companies within their
jurisdiction
– Adjustment based on spread of matching assets less fundamental
spread in respect of expected default and downgrade risk retained by
the company
– Subject to a floor of 75% of the long term average spread

10. Matching Adjustment
•Matching Adjustment (Matching Premium)
New article proposed for certain life insurance obligations
– Companies cannot apply Matching Adjustment in tandem with Adapted
Risk Free Rate and Spread Adjustment Mechanism
– Companies cannot actively switch between applying and not applying
Matching Adjustment
– Restrictions for non-compliance with conditions
– There will be reporting requirements for companies applying the
adjustment

11. Matching Adjustment
•Eligibility Criteria
– Replicating Portfolio of appropriate assigned assets
– Maintained over the lifetime of the life insurance obligation
– Ring-fenced and managed separately from the rest of the business
– No future premiums arising from the liabilities
– The liabilities should only be exposed to longevity, expense and
revision risk

12. Matching Adjustment
•Eligibility Criteria
– No policyholder options, or only a surrender option where the
surrender value does not exceed the value of the underlying assets
– The asset cashflows should be fixed, except for any dependency on
inflation, and should not be changeable by the issuers of the assets or
any third party
– The activities of the undertaking to which a matching adjustment can
apply are restricted to those carried out in the country where the
company is authorised.

13. Health Underwriting Risk Submodule
• EIOPA to publish standard deviations in relation to Member
States which use Health Risk Equalisation Systems subject
to the following requirements
(a) the mechanism for the sharing of claims is transparent and fully specified in advance of
the annual period to which it applies;
(b) the mechanism for the sharing of claims, the number of insurance undertakings that
participate in the health risk equalisation system (HRES) and the risk characteristics of the
business subject to the HRES ensure that for each undertaking participating in the HRES
the volatility of annual losses of the business subject to the HRES is significantly reduced
by means of the HRES, both in relation to premium and to reserve risk;
(c) health insurance subject to the HRES is compulsory and serves as a partial or complete
alternative to health cover provided by the statutory social security system;
(d) in the event of default of insurance undertakings participating in the HRES, one or more
Member States' governments guarantee to meet the policyholder claims of the insurance
business that is subject to the HRES in full.

14. Equivalence
• Temporary equivalence allowed for up to 5 years (with possible
extension of 1 year) for third countries that do not fulfil equivalence
criteria but satisfy certain conditions
• Proposed conditions for third country solvency regime include
– There must be written commitments from third country that equivalent regime will be
adopted before end of period
– Third country must have a convergence programme and demonstrate that it has
sufficient resources to carry out the programme
– Current third country solvency regime must be risk based, using an economic balance
sheet approach
– Other requirements cover independence of supervision, professional secrecy for
persons acting on behalf of third country’s supervisory authorities , exchange of
supervisory information
• Reinsurance contracts written in 3rd country with full or temporary
equivalence treated as if written under Solvency II regime

15. Post Implementation Review By EIOPA
• Subject to review 5 years after full Solvency II
implementation:
– Adapted risk free rate
– Extrapolation of risk free rates
– Symmetrical adjustment mechanism
• Matching adjustment subject to review 3 years after
full Solvency II implementation
– If found not to be appropriate then a transitional measure will be
applied

16. Other Developments
• Late 2011 Joint Working Group recommended
amendments to standard formula calibration for
– Health NSLT
– Non-life business
• Main changes proposed include
– Credit and Suretyship (premium risk factor down from 21.5% to 11.7%)
– Assistance (premium risk factor up from 5.0% to 9.3%)
– Marine, Transport Aviation (factors reduced by 2.1% for premium risk and
by 3.0% for reserve risk)
– Large fall in reserve risk factor for Medical Expenses (from 10.0% to 5.3%)
– Legal Expense reserve risk factor increased from 9.0% to 12.3%
– Miscellaneous Financial Loss reserve risk factor up from 15.0% to 20.0%