Solvency II professional knowledge presentation training 27032013

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Solvency II Training
Professional Knowledge
Leonhardt Wohlschlager
26/03/2013

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Introduction
Training
General information

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3 Objectives for 2 days [General information – Introduction Training]
Big picture
Solvency II
Project
Knowledge
© CGI 2013. All rights reserved
Solvency II
Capital
requirement
Benefits
Processes
Risk
definition
Governance
Market
solutions
Skills centre
Reference
People
Toolkit
Incidents &
Losses
Pillars
Definitions
CGI Risk & Regulatory – Training Solvency II – Professional Knowledge No. 3

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Basic terms are the Solvency Capital Requirement, standard formula and
internal model.
Solvency Capital Requirement:
The amount of capital to be held by an insurer to meet the Pillar I
requirements under the Solvency II regime. It is expected that the SCR may
be derived using either an approved internal model or the standard formula.
Standard Internal
Simpli-fication
full
Standard formula:
In the context of the Solvency II regime, a set of calculations prescribed by
the regulator for generating the Solvency Capital Requirement. The standard
formula is intended to be able to be used by a very wide range of
undertakings.
Internal model:
Risk management system of an insurer for the analysis of the overall risk
situation of the insurance undertaking, to quantify risks and/or to determine
the capital requirement on the basis of the company specific risk profile.
No. 4
Definitions and Terms [General information – Introduction Training]
CGI Risk Regulatory – Training Solvency II – Professional Knowledge
Internal
model
standard formula
and partial internal
model
standard formula
with undertaking-specific
parameters
standard formula

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Why
Solvency?
General information

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What is the customer interested in? [General information – Why Solvency II?]
How do we realize
Compliance with
minimum
implementation and
operation costs?
How do we fulfill our
periodical
repording duties in
time?
How can we initially
decrease operational
costs and effort per
annum and finally
further decrease it?
What is the impact of
the Solvency II
requirements
on the individual
business departments?
How do we realize
Solvency II
Compliance?
CGI Risk Regulatory – Training Solvency II – Professional © CGI 2013. All rights reserved
Knowledge No. 6

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Industry Drivers! [General information – Why Solvency II?]
Solvency II addresses risk across the three pillars – solvency capital, general
regulatory principles and financial disclosure and solvency
All Insurers with a European presence must meet Solvency II regulations by 2013, or
face review and penalties by the regulator
All firms can improve their competitive positioning in the market with
improvements across the three pillars
Get a grip on risk and deliver not only compliance, but also improved business
processes
CGI Risk Regulatory – Training Solvency II – Professional Knowledge No. 7

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No. 8
Analyst’s views [General information – Why Solvency II?]
Analyst’s views:
Gartner states that “Solvency II will lead to major changes for European
insurers and will affect most core insurance processes, including product
development, underwriting, marketing and sales.”
Ovum states that: “the move [to Solvency II] provides CIOs with a golden
opportunity to transform the information management landscape in their business
and provide a sharper competitive edge.”
The same analyst quotes that “This is likely to be the largest IT project since Y2K.”
Firms need a partner they trust to deliver and respond to future changes

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Understanding the customer’s requirements
[General information – Why Solvency II?]
Solvency II (SII) is a “no fail” programme with challenging
timelines. SII programmes face a number of challenges that
if not managed correctly put significant pressures on both
cost and deadlines:
• Requirements are constantly emerging – e.g. QIS results
and changing rules on asset eligibility for ORSA.
• Data management requirements are complex and people
intensive.
• As SII is new to the industry delivery planning is not
based on prior experience.
• There are many stakeholders and business functions
involved across LBU/LoBs which adds complexity and
means careful co-ordination and management is
required.
• The large scope of work within an immovable timeframe
requires a heavy resource profile which incurs additional
management overhead.
• There is a need to prove the conceptual design before
spending money on full production systems.
No. 9
“something someone has said,
does not need to be a direct
quote because of ambiguity in
reference”
Position of a person with this
requirement01

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Financial
Crisis News
General information

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Financial markets are complex. The insurance industry has not been
immune to the effects of the financial crisis as insurers have significant
asset bases that were affected by the depressed market values of assets.
‘The economic crisis has triggered a phase of profound reflections for all —
European institutions and industry — on the lessons to be learned from the
financial crisis. A key lesson is that financial supervision must be
improved.’ (Insurance Europe, formerly CEA, Comité Européen des
Assurances)
‘EU legislators should not water down the Solvency II directive or
postpone the legislative process. This would be like terminating a
marathon at the 40 kilometer mark.’ (CRO Forum)
‘The crisis originated and developed in the banking sector,
subsequently spreading to the insurance sector. Our main lesson of the
current events is that Solvency II must be adopted. […] The crisis has
highlighted needs for a further refinement of the existing Solvency II
calibrations, both at module and sub-module levels. […] As in the financial
sector at large, governance, risk management, and internal controls in the
insurance sector need to be strengthened. […]’ (European Insurance and
Occupational Pensions Authority, formerly CEIOPS)
Source: CRO Forum /Press Release: Financial Crisis strongly reinforces the case for Solvency II 24/10/2008; CEA /Solvency II CEA Key Messages on Level 2
Implementing Measures; CEIOPS /Lessons learned from the crisis (Solvency II and beyond) 2009/; legend: CRO – Chief Risk Officer
No. 11
Financial crisis and Solvency II [General information – Financial Crisis News]

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Solvency II News today [General information – Financial Crisis News, Germany specific]
R.ecent headlines from daily press, legislation and jurisdiction create an
image about the responses of the insurance industry to Solvency II.
Solvency II
in 2016?
New rules for insurance
regulation are expected to arrive later!
Source: Nov. 2012
© CGI 2013. All rights reserved No. 12

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Risk
Management
General information

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After this section you have general knowledge about:
No. 14
Overview [General information – Risk Management]
Risk fundamentals
Definition of risk
Key components of risk
Risk measures
Solvency II risk types
Mitigation and transfer

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The overall management of an insurer includes:
Design, pricing, marketing and underwriting of insurance policies
Selection of assets backing the policies
Estimation of the size and volatility of the liabilities associated with the
policies
Determination of the insurers’ capital needs
No. 15
Risk Fundamentals [General information – Risk Management]
Claims Management
Adequate disclosure and communication process to key stakeholders
Future financial condition analysis which provides a multi-scenario view

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There are many definitions of Risk. The one below was published in 2004 by
Standards Australia and Standards New Zealand on Risk Management.
‘A risk is often specified in terms of an event or circumstance and the
consequences that may flow from it.’
‘Risk is measured in terms of a combination of the consequences of an
event […] and their likelihood […].’
‘Risk may have a positive [then it is often called a chance] or negative
impact.’
‘See ISO/IEC Guide 51, for issues related to safety.’
Source: Standards Australia/Standards New Zealand 4360:2004, p. 4
No. 16
Definition of Risk [General information – Risk Management]

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Perils, assets, incidents and losses define a risk, quantifiable as product of
probability and extent of loss.
Definition:
– Particular set
of circumstance/
events, risk source
Perils examples:
– Credit default
– Insured liability
events
Asset Loss
No. 17
Key components of risk [General information – Risk Management]
Peril
Incident
Definition:
– Financial negative outcome
or impact of an event
Loss examples:
– Storm catastrophe that leads
to claims of 4 m. Euro.
– Loss of 0,1 m. Euro due to a
delay in orders confirmations
due to an inaccurate
procedure
Definition:
– Asset that is
vulnerable
to a certain type of
threat
Asset examples:
– Insured object
– IT component
Definition:
– Occurrence of an event
which could eventually
generate losses
Event examples :
– Natural disaster
– Damage to physical
assets due to a flooding
Definition:
Probability
of loss
occurring X
extent
of loss if loss
occurs

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No. 18
Example of Risk [General information – Risk Management]
Peril
Asset
Incident
Loss
Accident
Car
Mr. Smith damaged
Mrs. Dupont’s Bentley in
Admiraliteitsstraat.
Damage was insured and
accounts for 5.500 £.
Car damage:
Expected
risk value is
2.546 £.
Assumption:
Decision-maker
risk-neutral

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From the actuarial perspective, there is special attention to the volatility,
uncertainty and extreme events of risk for each peril.
Definition
Risk Measure is a function of the probability distribution of losses.
Function
Risk Measure is used to determine either the total capital requirement or an
indicated capital requirement for a component. Risk Measures can be
visualised with data in a Normal distribution. A bell curve (normally distri-buted
random variable) can be described by mean (expectation) and
standard deviation.
Examples
Value at Risk (VaR) that is used to determine the solvency capital require-ment,
is a quantile of a distribution. The 99,5th percentile of the distribution
is the value for which there is a probability of exceedence of 0,5%.
The volatility is a measure for price variation of a financial instrument over
time.
The risk margin represents the value of the deviation risk of the actual
outcome compared with the best estimate.
Extreme events such as an earthquake catastrophe lead to a Chi-Quadrat
curve.
No. 19
Risk Measures Summary [General information – Risk Management]

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In order to calculate the economic capital (= SCR) one needs to aggregate
all PL probability distributions.
No. 20
Aggregation of loss distributions [General information – Risk Management]
Source: European Union /DIRECTIVE 2009/138/EC/; legend: PL – Profit Loss Distribution, EL – Expected loss (mean)

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Economic Capital [General information – Risk Management]
The SCR is the capital required to cover a ruin probability based on risk
evaluation (VaR), confidence level in a 1 year time horizon.
No. 21
Frequency
of occurence
Loss distribution
Value X (VaR)
EXPECTED
LOSS
(Technical provisions)
UNEXPECTED
LOSS
(Economic capital)
P = 0,005
(Risk appetite*)
Economic Capital
=
SCR
(Unexpected loss)
Mean (Expected loss)
=
Risk provisions
Source: European Union /DIRECTIVE 2009/138/EC/; legend: Risk appetite is a business term, usually called confidence level in maths.

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The main Solvency II risk types include the underwriting risk (health, life,
non-life), the market, counterparty default and intangible assets risk.
Market Health Default Life Non-life Intang
Legend: Adj – Adjustment, CAT – Catastrophe, Op – Operational risk, SLT – similar to life techniques
No. 22
Solvency II Risk Types [General information – Risk Management]
SCR
Adj BSCR Op

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The main Solvency II risks are called risk modules ...
Underwriting risk
The risk of a change in value due to a deviation of the actual claims
payments from the expected amount of claims payments (including
expenses). From the nature of the administration of risk within the
company, one can distinguish between risks of claims which have already
happened in the past – the reserve risk, and the risk of claims which will
happen in the future – the premium risk.
Examples: life underwriting risk, windstorm underwriting risk
Market risk
The risk of changes in values caused by market prices of financial
instruments or volatilities of market prices differing from their expected
values. Exposure to market risk is measured by the impact of movements
in the level of financial variables such as stock prices, interest rates, real
estate prices and exchange rates.
Example: interest rate risk
Source: CEA /Solvency II Glossary 2013/; European Commission /QIS5 Technical Specifications 2010/ p. 90 ff.; legend: risk types that were used in QIS5
No. 23

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… as they are taken into account to determine the Solvency Capital
Requirement.
Counterparty default risk
The risk of possible losses due to unexpected default, or deterioration in the
credit standing, of the counterparties and debtors of undertakings.
Example: reinsurance counterparty risk
Intangible assets risk
The risk of a change in value derived from a decreasing price of an
intangible asset in the active market and from unexpected lack of liquidity
of the active market that may result in an additional impact on prices, or
due to internal risks inherent to the specific nature of the intangibles.
Goodwill is excluded.
Example: Risk of price decrease of patents due to revolutionary
innovations
Source: CEA /Solvency II Glossary 2013/; European Commission /QIS5 Technical Specifications 2010/ p. 90 ff.; legend: risk types that were used in QIS5
No. 24

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In order to lessen the risk, the insurer applies various risk instruments. For
the underwriting risk, it is usually reinsurance and, alternatively, ART, for
operational risk, insurers use internal controls.
Definition
The insurers’ steps to lessen the risk associated with its business.
Examples
Purchase of reinsurance
Alternative risk transfer (ART)
securitization of a portion of its asset or liability portfolio
hedging of financial guarantees with derivates instruments
product design
active risk management.
Source: European Commission /QIS5 Technical Specifications 2010/ 90 ff.
No. 25
Mitigation and Transfer [General information – Risk Management]

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An overall generalized model for risk management can be drawn as follows.
In case of underwriting risk incidents, insurers use the term ‘claims’ for loss.
No. 26
Mitigation and Transfer [General information – Risk Management]
Incident
From 0 to N
incidents
Risk
Action plan
ERMS
From 1 to N
ERMS
From 0 to N
action plans
Planed or ongoing action:
Ex: Documentation of a
procedure, training, Set
up of an automated
control
ERMS = Element of
the Risk Management
System: current
elements in place:
Ex : IT controls,
procedures, internal
audit control plan
Real cases;
occurrence of a risk
A finalized action plan can be changed
into an ERMS:
Ex : A published procedure becomes
an ERMS
Legend: ERM – Enterprise Risk Management, ERMS – Enterprise Risk Management Systems

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Define the term risk!
Of which components consists a risk? Take an example!
For which risk modules does one have to calculate solvency capital, e.g.
STEC (= short term economic capital), according to the Solvency II regime?
How much is the risk appetite, that is proposed by the Solvency II
Directive?
Explain the steps to calculate the Economic Capital!
No. 27
Exercises [General information – Risk Management]

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Solvency II
Data Reference
Model
Specific information

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After this section you have specific knowledge about:
Solvency II projects
SCR calculation process industrialization
Solvency II Data Model
Calculation chain for SCR Non Life
Benefits of our data reference model
Partner
No. 29
Overview [Specific information – Solvency II Data Reference Model]

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SCR Calculation Process Industrialisation [Specific information – Solvency II Data
Reference Model]
We have designed a data reference model to industrialize the process of
SCR calculation.
Solvency II requirements
(Directive + Consultation Papers)
LMC Solvency II and Basel II Project
Internal Model,
data reference,
LBC
Project
Implementation
• Allianz
• Groupama
• …
This is where our model provides:
A Roadmap to reach the
industrialization objective
A detailed view of each process and
step
A detailed view of data required
Best practices for aggregation and
treatments
Data Quality preset of deliverables

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Data Model Overview [Specific information – Solvency II Data Reference Model]
The data model has some Solvency II specific key dimensions.
Agregates for
all Risk
families
QIS 4 and
QIS 5
compliant
Fits internal
model or
standard
formula
requirement

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A Catalyst for SII Development [Specific information – Solvency II Data Reference Model]
To help through all these steps, our data reference model sustains
processes and data required for SCR computation.
Collect Data for each
Calculate by Risk family
(Assets, market, L,
Risk Family
Aggregate Data, Preprocess,
transform, pre/post analyze
NL,..)
FFiinnaall aaggggrreeggaattiioonn
Identify Data
(dependent
from models,
risks, QIS
stage,…)
SShhaarree//AAnnaallyyzzee

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Internal Model Flows Mapping [Specific information – Solvency II Data Reference Model]
The model includes a generic description of internal models flows and
mapping: CAT and Non Life.

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Process Specification [Specific information – Solvency II Data Reference Model]
The model presents the related sub processes and details them.

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Detailed View of Process 1 [Specific information – Solvency II Data Reference Model]
For example, the steps of large claims data preparation for DWH can be
described as follows:
L1: Claims data extract from DWH (150k criterion)
A1: Co-insurance rate application to get the company part
L2: Manual release of data organization table
A2: mapping data update
L3: success of local brokerage data identification
L4: data enrichment with A2 mapping
A3: enriched and aggregated data input in DWH
L5: data are ready for triangles
A4: triangles setting
L6: success of triangles constitution
A5: triangles are calculated for descriptive statistics triangles calculations
L7: triangles calculations taking into account L8 exclusions
A6: business analysts can modify previously calculated data
L8: business analysts can exclude some development indicators. Statistic data have to be automatically calculated.
R1: Data to input in DWH have the right format to be copied/pasted in the appropriate templates
L3

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2006 100 110 150 160 165 165 165
2007 95 105 120 130 130 131
2008 110 120 135 137 140
2009 120 135 150 165
2010 125 130 150
2011 154 165
2012 143
Development year
N N+1 N+2 N+3 N+4 N+5 N+6
N N+1 N+2 N+3 N+4 N+5 N+6
Min 95 105 120 130 130 131 165
Average 121 127,5 141 148 145 148 165
Max 154 165 150 165 165 165 165
No. 36
Loss triangle and statistic data [Specific information – Solvency II Data Reference Model]
Statistics Subscription year

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Loss triangle and development coefficients [Specific information – Solvency II Data
Reference Model]
Subscription year
No. 37
Development year
N/A N ⇒
N+1
N+1 ⇒
N+2
N2 ⇒
N+3
N+3 ⇒
N+4
N+4 ⇒
N+5
N+5 ⇒
N+6
2006 N/A 10,00% 36,36% 6,67% 3,13% 0,00% 0,00%
2007 N/A 10,53% 14,29% 8,33% 0,00% 0,77%
2008 N/A 9,09% 12,50% 1,48% 2,19%
2009 N/A 12,50% 11,11% 10,00%
2010 N/A 4,00% 15,38%
2011 N/A 7,14%
2012 N/A
Average N/A 8,88% 17,93% 6,62% 1,77% 0,38% 0,00%

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Forecasts using development coefficients [Specific information – Solvency II Data
Reference Model]
1 Development year
2006 100 110 150 160 165 165 165
2007 95 105 120 130 130 131 131
2008 110 120 135 137 140 140 140
2009 120 135 150 165 165 165 165
2010 125 130 150 150 150 150 150
2011 154 165 165 165 165 165 165
2012 143 155,69 183,61 195,76 199,23 200 200
No. 38
N N+1 N+2 N+3 N+4 N+5 N+6
Subscription year

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No. 39
Gross loss triangle of Generali [Specific information – Solvency II Data Reference Model]
Source: Generali (ed.) /Annual Report 2011/

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Detailed View of Process 1 [Specific information – Solvency II Data Reference Model]
The overall view of the whole calculation chain for SCR Non Life
Triangles
Step 1 Step 2
Triangles
Non Life Premium
and reserve
Source Data
(Systems)
Catastrophe
Source Data
(Systems)
Triangles Triangles
TTrriiaanngglleess Triangles
Intermediate
data storage
Intermediate
data storage
Non Life
Premium and
reserve Risk
Non Life
Catastrophe
Risk
NON LIFE
SOLVENCY II
CAPITAL
REQUIREMENT
TTrriiaanngglleess Triangles
Triangles Triangles

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SCRNL Premium Reserve Risk [Specific information – Solvency II Data Reference Model]
In Step 2 the calculation chain for SCR Non Life is focused (1/2).
Intermediate
data storage
On the left side is a picture of a UML data model for SCR Non Life Premium and Reserve risk storage.
On the right side is a picture of a UML data model for SCR Non Life Premium and Reserve risk calculation.

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SCRNLCatastrophe Risk [Specific information – Solvency II Data Reference Model]
In Step 2 the calculation chain for SCR Non Life is focused (2/2).
On the left side is a picture of a UML data model for SCR Catastrophe risk storage.
On the right side is a picture of a UML data model for SCR Catastrophe risk calculation.
Intermediate
data storage

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SCR NL Premium, Reserve Risk Catastrophe
Intermediate Data [Specific information – Solvency II Data Reference Model]
This diagram is a schematic view of the different storage tables needed for
the calculation of the SCR Non Life Premium and reserve risk.
Solvency II Non Life Basic Data
• Volume measures for premium risk
• Overall standard deviation
• A function of the standard deviation
• SCR Non Life Premium and
Reserve risk
• SCR Non Life Catastrophe risk
Date
• Written Premiums
• Earned Premiums
• Earned Exposures
• Total paid losses and Allocated Adjustment
Expenses (ALAE)
• Paid losses and ALAE on closed claims
• Loss and ALAE case reserve
• Salvage and Subrogation Recoveries on
Total Paid Losses Paid ALAE
• ALAE case reserves
• Paid Annuities
• Annuity case Reserves
• Total Number of Reported Claims
• Total Number of Closed Claims
• Number of Closed Claimed with no Loss
Payment
• Number of Reopened Claims
• Expected Written Premiums
• Expected Earned Premiums
• Best Estimate of Claims Outstandings
• Volume measures for premium risk by lob
• Volume measures for reserve risk by lob
• Overall volume measures by lob
• Overall standard deviation by lob
• Standard deviation for Premium Risk by lob
• Standard deviation for Reserve Risk by lob
• Volume measures for premium risk by
lob and country
• Volume measures for reserve risk by
lob and country
• Loss Ratio
• Earned Premiums
• Written Premiums
• Total Paid Claims
• Total Claim Reserve
• Total Claims Recoveries
• Reinsurance Code
• Description in English
• Description in local
language
• Description in English
• Description in local
language
• LOB Code
• LOB description in English
• LOB description in local language
• Identification
Date
• Fiscal Period
Description
• Fiscal Period Code
• Company Code
• Country Code
• Sub LOB Code
• Sub LOB description in English
• Sub LOB description in local
language
• Exposure description in English
• Exposure description in local
language
• Claim type Code
• Claim type description in English
• Claim type description in local
language
Non Life Volume and standard
deviation Global
Non Life Volume and standard deviation
by LOB
Solvency II Non Life Historical
Data
Non Life Volume measures by
LOB and Country
Reinsurance code
Valuation Date
Company
Country
Sub LOB
Claim type
Line Of Business
Fiscal Period

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SCR NL Premium, Reserve Risk Catastrophe
Intermediate Data [Specific information – Solvency II Data Reference Model]
This diagram is a schematic view of the different calculation steps of the
SCR Non Life Premium and Reserve risk.

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Non Life facts overview (UML) [Specific information – Solvency II Data Reference Model]
This diagram represents all relevant non-life data.

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Our data reference model brings several benefits.
It allows our customer to:
Steer the IT project
by providing a common framework for discussion between business and IT participants
Design a model
by providing sources of data and proposition of current processes for all risks families
(though only Assets/Credits, Cat and Non-Life have been fully modelized)
Build Implement a solution
by providing best practices recommendations of implementation (in a SAP BI
environment)
Optimize the « Run Use » of the solution
Reportings Controlling supports
No. 46
Data Reference Model Benefits [Specific information – Solvency II Data Reference Model]

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The chart provides a General view of an infrastructure for Data processing
and management under Solvency II regime.
No. 47
Solvency II Data Processing Management Infrastructure
[Specific information – Solvency II Data Reference Model]

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Our Data reference model serves as an accelerator to design build our
clients’ Solvency II architecture.
No. 48
Data Reference Model as Accelerator
[Specific information – Solvency II Data Reference Model]

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We are finalizing the Reference data model with our partner Prima Solutions.
Founded in 2000 Prima Solutions operates
globally from offices in Paris, London, Chicago
and Tokyo.
Combination of standards, software and services
which allows for structured processing of
enterprise information enabling greater control
and data integrity across their organization.
Three main products :
Prima Repository: suite of components for
insurance applications
Prima Vanilla: Services for Contract/Policy
management applications
Prima IBCS: object-oriented insurance model
suite
Prima Solutions’ technology promotes Reusability
and renewed Business and Technical Agility.
CGI, now part of CGI, and Prima work together to adapt Insurance standard's
model (IBCS) in order to fit Solvency II requirements.
No. 49
Our Solvency II partner [Specific information – Solvency II Data Reference Model]

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Brainstorming:
Worin bestehenden die Unterstützungspotenziale der CGI im Hinblick auf
Säule-1-Projekte?
No. 50
Brainstorming [Specific information – Solvency II Data Reference Model]

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Reinsurance
General information

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Reasons for reinsurance
Types of Reinsurance
Reinsurance and Risk Profile
Reinsurance Credit Risk
No. 52
Overview [General information – Reinsurance]

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Reinsurance – a Law to Business Translation [General information – Reinsurance]
“The cedent cedes the cession to the cessionary.”
No. 53
In law you say.
Insurer transfers risk to reinsurer.

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There are two main objectives to purchase reinsurance.
One is the genuine transfer of risk, the other can be described as a risk transfer
for the purposes of managing or spreading risk over time or achieving strategic
business objectives.
Genuine risk transfer reasons primarily include:
Limiting large or catastrophic claims
Limiting total claims
Strategic or financial objectives include:
Increasing new business capacity
Investment Risk Transfer
Financial Results Management
A mixture of both objectives can provide for:
Gaining Product Expertise
Underwriting Advice
Divesting a Product Line
No. 54
Reasons for Reinsurance [General information – Reinsurance]

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Reinsurance covers typically have two different types: proportional or non-proportional.
Proportional reinsurance covers are quota share or surplus covers, while non-proportional
covers comprise excess-of- loss or stop-loss contracts. Both types
are often, mixed or aggregated.
Example “Proportional reinsurance”:
No. 55
Types of Reinsurance [General information – Reinsurance]
Purchase a
policy
Pay premium
Transfer portion
of premium
Another
Insurance
company
Individual/Common
Person Or
Group of
Individuals/
Industries
Insurance
Company
Reinsurance
Company
Insured Insurer Reinsurer

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Reinsurance contracts typically have significant impacts on the company’s
aggregate risk profile.
… usually with the effect of reducing risk, and those are important
considerations for the capital requirement of an insurance company.
While proportional reinsurance reduces the overall (nominal) risk in a linear
way, non-proportional covers the large losses, thereby reducing the company’s
net exposure to large loss or catastrophic events.
No. 56
Reinsurance and Risk Profile [General information – Reinsurance]

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Reinsurance arrangements often generate a long-term relationship between
cedant and reinsurer.
The stability of the relationship crucially depends upon the financial strength of
the reinsurer.
To recognize the credit risks on the reinsurance recoverable, a factor 0 can be
applied to the full amount of capital relief derived from having a reinsurance
arrangement in place. The factor 0 may vary depending upon:
• Financial stability of the reinsurer
• Amount of collateral being posted
• Nature of the reinsurance (i.e. short versus long tail)
• Concentration risk
No. 57
Reinsurance Credit Risk [General information – Reinsurance]

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Solvency II
Regulation
General information

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No. 59
Overview [General information – Solvency II Regulation]
Three Pillars
Timelines Solvency II
Related regulatory

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Pillar 1 comprises quantitative requirements, Pillar 2 the supervisory review
process and Pillar 3 the disclosure requirements.
Pillar 1
Technical Provisions
Standard Model
MCR
SCR
Own Funds
QIS
Pillar 2
Governance
Supervisor Review
Process
Risk Management
ORSA
Pillar 3
Disclosure
Report to Supervisor
Solvency and
Financial Condition
Report
No. 60
Three Pillars [General information – Solvency II Regulation]

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The three pillars conclude high data quality ...
No. 61
Pillar 1:
Measuring the financial position and capital adequacy (SCR, Minimum
Capital Requirement, reserves, integration of all quantifiable risks, capital
rules, investment rules, asset liability management)
Pillar 2:
Integration of all non-quantifiable risks, Own Risk and Solvency
Assessment (ORSA), supervisory intervention (e.g. ACAM, BAFIN etc.)
Pillar 3:
Disclosure Solvency Financial Condition Report
Market discipline
Source: European Commission /QIS5 Technical Specifications 2010/

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… and robust controls.
Pillar 1:
Quantitative
Requirements
Pillar 2:
Supervisory Review
Process
Pillar 3:
Disclosure
Requirements
No. 62
•Technical Provisions
•Investment rules and ALM
•Capital rules
•Own Risk and Solvency
Assessment (ORSA)
•Supervisory Intervention
•Disclosure Solvency
Financial Condition Report
•Market Discipline
Robust Internal controls around risk data collection and
storage
Risk assessments based on accurate, complete and
appropriate historical data
Accuracy and consistency between capital calculation
data and wider reporting data
Source: European Commission /QIS5 Technical Specifications 2010/

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On 31st December 2013 every insurer is supposed to comply with the
Solvency II regulation.
2013 Directive transposition,
QIS 5 report
2010 Scoping Delivery: Directive
transposition, QIS 5
2009 Scoping: Directive transposition, Scoping of activities,
Organization and planning of the project, Risk Management
2008 Studies: Directive negotiation, CEIOPS works on pillar I II, QIS 4
2007 Studies: Directive negotiation, CEIOPS works on pillar I II, QIS participation,
QIS 3, Impact Studies, Lobbying
No. 63
Timelines Solvency II [General information – Solvency II Regulation]
2013 Delivery,
transposition

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Timelines Solvency II [General information – Solvency II Regulation]
There are just 31 months left till the first quarterly reporting.
2013 2014 2015
2012
IRSG: „18 months between assurance of
reporting requirements till the full
implementation of S II are necessary.“*
31 months till the 1. quarterly
reporting
Q3/Q4
Solvency II
put into
national
law
1.1.2015:
Solvency II
Go-Live
May 2015:
Hand-in
QRTs Q1
and country
reports
Q2: EIOPA
sends final
proposals
and
finalizes
guidelines
* Source: EIOPA Insurance and Reinsurance Stakeholder Group – Opinion Consultation – Reporting Package; Nov. 2012
© CGI 2013. All rights reserved No. 64

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As well other regulatory has to be taken into account.
International Financial Reporting Standards
National legislation (e.g. MaRisk(VA), HGB, AktG for Germany)
No. 65
Related regulatory [General information – Solvency II Regulation]

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Technical
Provisions

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No. 67
Overview [General information – Pillar I – Technical Provisions]
Proportionality
Best estimate
Risk Margin
Reinsurance recoverables
Frequency of calculations

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The principle of proportionality allows a reduction of complexity of the
valuation methodology.
The purpose and role of a proportionality assessment is interlinked with the
selection of an appropiate valuation methodology. It then considers the notion
of estimation uncertainty and why this is central to proportionality assessment.
The assessment of proportionality of the selected valuation methodology to the
nature, scale and complexity of the underlying risks is an integral part of this
process. Three elements of such an assessment are:
Step 1: assess nature, scale and complexity of underlying risks
Step 2: check whether valuation methodology is proportionate to risks as
assessed in step 1, having regard to the degree of model error resulting
Step 3: Back test and validate the assessment carried out in step 1 2
Source: CEIOPS /Technical Provisions 2009/ p. 9 ff.
No. 68
Proportionality [Specific information – Pillar I – Technical Provisions]

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The best estimate represents the discounted probability-weighted average
of future cash flows (also called present value).
Simplified methods are used for the valuation of the best estimate element of
technical provisions in the context of a proportionality assessment.
The principle of proportionality provides an adequate framework to ensure
that undertakings apply appropriate methodologies for the valuation of
technical provisions, including the use of simplified techniques.
No. 69
Best estimate [Specific information – Pillar I – Technical Provisions]

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The risk margin represents the value of the deviation risk of the actual
outcome compared with the best estimate.
For the calculation of the risk margin, EIOPA states that the risk margin shall
be calculated per line of business.
The calculation of the risk margin per line of business shall in general be
carried out according to the following steps:
1. Project the SCRs throughout the lifetime of the (re)insurance obligations
2. Apply the Cost-of-Capital rate to the projected yearly SCRs
3. Discount with the risk-free interest rate curve
4. Accumulate the amounts over all future years
No. 70
Risk Margin [Specific information – Pillar I – Technical Provisions]

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The calculation of the amount of recoverables from reinsurance contract of
life insurance business should be based on policy-by-policy approach.
Reinsurance recoverables = gross provisions – net provisions
The steps to integrate the derived net valuations of technical provisions into the
Solvency II Framework are:
• Step 1: Derive valuation of technical provisions net of reinsurance
• Step 2: Determine reinsurance recoverables as difference between gross and
net valuations
• Step 3: Assess whether valuation of reinsurance recoverables is compatible
with Article 81.
No. 71
Reinsurance recoverables [Specific information – Pillar I – Technical Provisions]

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In Solvency II evaluation principles for the calculation of the technical
provisions, such as the best estimate and risk margin, are applied.
Solvency II reserves (technical
provisions) =
best estimate + risk margin
– Best estimate: discounted probabili-ty-
weighted average of future cash
Risk 1 Risk 2 Risk 3
Legend: European Union /DIRECTIVE 2009/138/EC/ p. 45 f.; CEA /Solvency II CEA Key Messages on Level 2, legend: PV – present value.
* The probability-weighted average of future cash flows is as well often refered to as mean, the discounted one as expected present value of future cash flows.
No. 72
Risk Evaluation [Specific information – Pillar I – Technical Provisions]
flows (also called PV)*
– Risk margin: to ensure that
technical provisions are equivalent
to amount that insurance under-takings
would be expected to
require in order to take over and
meet the insurance liabilities.
Valuation principles
– Prudent under Solvency I
– market-consistent under Solvency II
Solvency I Solvency II
Margin requirement
(simplified example)
Premiums
(Non life)
Mathematical
reserves
(life)
X 16% = Margin
Non Life
+
X 4% = Margin
Life
Total Margin
Margin requirement
Internal
model
Probability
Ruin
Results

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Equity capital includes free surplus and SCR.
Liabilities Liabilities
Risk Margin
Economic view:
Ruin is the moment where liabilities exceed assets
Solvency Capital Requirement (SCR): Capital required to cover a ruin probability based on:
risk evaluation (VaR), confidence level (99,5%) and a time horizon of 1 year.
No. 73
Risk Evaluation under Solvency II [Specific information – Pillar I – Technical Provisions]
Assets
Assets
Market Value
as
counterpart
of
SCR/MCR
and technical
provisions
Equity Capital
Risk Margin
Free Surplus
Best Estimate
Market
consistent
evaluation
MCR
Best
Estimate
Market
consistent
evaluation
SCR
Source: European Union /DIRECTIVE 2009/138/EC/ p. 77 f.; for more details see the so-called QIS5 spreadsheet ‘I.Valuation’

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According to the Directive the SCR should be calculated at least once a year
and the MCR at least quarterly.
Insurance and reinsurance undertakings shall calculate the Solvency Capital
Requirement at least once a year and report the result of that calculation to
the supervisory authorities.
Insurance and reinsurance undertakings shall calculate the Minimum Capital
Requirement at least quarterly and report the results of that calculation to
supervisory authorities.
Since the objective of the quarterly MCR calculation is to ascertain whether or
not the MCR has been breached, the own funds eligible to cover the MCR
should also be calculated in parallel on a quarterly basis.
Source: European Union /DIRECTIVE 2009/138/EC/ p. 60
No. 74
Frequency of calculation [Specific information – Pillar I – Technical Provisions]

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SCR
Calculation

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SCR Methods and Formulas
Principle of Proportionality
No. 76
Overview [Specific information – Pillar I – SCR Calculation]

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There a number of ways to calculate capital for solvency and regulatory
purposes with regard to one specific risk module.
Here are five common and not so common methods used for calculating the
Solvency Capital Requirement (SCR):
Those models and methods are “BLACK BOXES” in our data reference model.
We feed them and extract from them, no more, no less.
No. 77
SCR Methods Formulas [Specific information – Pillar I – SCR Calculation]
Examples
Covariance matrix
Replicating portfolios
Least squares Monte Carlo
Curve-fitting
Nested stochastic

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Proportionality is as well applied for the SCR calculation.
In particular, this Directive should not be too burdensome for insurance
undertakings that specialise in providing specific types of insurance or
services to specific customer segments, and it should recognise that
specialising in this way can be a valuable tool for efficiently and effectively
managing risk.
In order to achieve that objective, as well as the proper application of the
proportionality principle, provision should also be made specifically to allow
undertakings to use their own data to calibrate the parameters in the
underwriting risk modules of the standard formula of the Solvency Capital
Requirement.
No. 78
Principle of Proportionality [Specific information – Pillar I – SCR Calculation]

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Standard
Formula

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Solvency II Standard Formula
Solvency II Risk Types
Non-life Underwriting Risk Types
No. 80
Overview [General information – Pillar I – Technical Provisions]
Market Risk Types
Life Risk Types
Health-specific Risk Types
Operational Risk

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The SCR finally accumulates the Basic Solvency Capital Requirement (SCR),
the SCR for operational risk and the adjustment as input data.
SCR= BSCR + SCROp + Adj
The standard formula is the method undertakings are expected to use to
calculate the SCR when they do not have their own internal model.
The standard formula should therefore be suitable for calculation, in
particular by smaller firms.
In QIS2 there are two methods for the standard formula being tested.
Both take a modular approach to the assessment of capital i.e. the capital
requirement is calculated for each risk factor separately and an overall capital
requirement is then calculated using assumed correlation between the
various risk factors.
No. 81
Standard Formula [Specific information – Pillar I – Standard Formula]

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The calculation of the Solvency Capital Requirement according to the
standard formula is divided into modules as follows …
Market Health Default Life Non-life Intang
Interest rate SLT Health CAT Non-SLT Health
No. 82
Solvency II Risk Types [Specific information – Pillar I – Standard Formula]
SCR
Adj BSCR Op
Premium Res. Longevity
Mortality
Longevity
Disability
Lapse
Expenses
Revision
Equity
Property
Spread
Currency
Concentration
Illiquidity
Lapse
Mortality
Disability
Lapse
Expenses
Revision
CAT
Premium Res.
Lapse
CAT
included in the adjust-ment
for the loss absor-bing
capacity of technical
provisions under the mo-dular
approach
=
Source: European Commission /QIS5 Technical Specifications 2010/ 90; legend: Adj – Adjustment, CAT – Catastrophe, Op – Operational risk, SLT – similar to life techniques

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The non-life underwriting risk module consists of the non-life premium risk,
non-life reserve risk ...
Premium risk
The risk of loss, or of adverse change in the value of insurance liabilities,
resulting from fluctuations in the timing, frequency and severity of insured
events. Premium risk relates to policies to be written (including renewals)
during the period, and to unexpired risks on existing contracts. Premium
risk includes the risk that premium provisions turn out to be insufficient to
compensate claims or need to be increased.
Reserve risk
resulting from fluctuations in the timing and amount of claim settlements.
Source: European Union /DIRECTIVE 2009/138/EC/ p. 52-53; European Commission /QIS5 Technical Specifications 2010/ p. 197 ff.
No. 83
Non-life Underwriting Risk Types [Specific information – Pillar I – Standard Formula]

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… non-life catastrophe risk and lapse sub-modules.
Catastrophe risk
resulting from significant uncertainty of pricing and provisioning
assumptions related to extreme or exceptional events
Lapse risk
The risks of a change in value caused by deviations from the actual rate of
policy lapses from their expected rates.
No. 84
Non-life Underwriting Risk Types [Specific information – Pillar I – Standard Formula]

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The market risk module consist of interest risk, equity risk, property risk,
spread risk …
Interest rate risk
resulting from significant uncertainty of pricing and provisioning
assumptions related to extreme or exceptional events
Equity risk
The risk of a change in value caused by deviations of the actual market
values of equities and/or income from equities from their expected values.
Property risk
Property risk arises as a result of sensitivity of assets, liabilities and
financial investments to the level or volatility of market prices of property.
Spread risk
The risk of a change in value due to a deviation of the actual market price
of credit risk from the expected price of credit risk.
Source: European Union /DIRECTIVE 2009/138/EC/ p. 52-53; European Commission /QIS5 Technical Specifications 2010/ p. 110 ff.; 116
No. 85
Market Risk Types [Specific information – Pillar I – Standard Formula]

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… concentration risk and illiquidity risk.
Concentration risk
The exposure to increased losses associated with inadequately diversified
portfolios of assets and/or obligations. Concentration risk for an insurer
may arise with respect to investments in a geographical area, economic
sector, or individual investments, or due to a concentration of business
written within a geographical area, of a policy type, or of underlying risks
covered.
Illiquidity
The risk stemming from the lack of marketability of an investment that
cannot be bought or sold quickly enough to prevent or minimize a loss.
Liquidity risk may arise due to illiquidity of the assets held to meet the cash
flow requirements (commonly referred to as asset, market, or trading
liquidity risk), but also due to insufficient funds being available to meet
cash flow requirements (funding liquidity risk). From a more theoretical
point of view liquidity risk on a day-today basis could also be understood as
a change in value due to a deviation of the actual cash flow requirements
from the expected cash flow requirements, being the cost of being over- or
under capitalised.
No. 86
Market Risk Types [Specific information – Pillar I – Standard Formula]

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The life risk module consist of mortality risk, longevity risk, disability risk ...
Mortality risk
Type of biometric risk. A change in value caused by the actual mortality
rate being higher than the one expected. An increase in the frequency of
the death of insured persons may for example result in higher claim
patterns than charged for in the premiums.
Longevity risk
Type of biometric risk. A change in value caused by the actual mortality
rate being lower than the one expected. Longevity risk affects contracts
where benefits are based upon the likelihood of survival, i.e. annuities,
pensions, pure endowments, and specific types of health contracts.
Disability risk
A change of value caused by a deviation of the actual randomness in the
rate of insured persons that are incapable to perform one or more duties of
their occupation due to a physical or mental condition, compared to the
expected randomness. Disability risk only relates to cover against loss of
income, contrary to morbidity risk, relating to cover other than loss of
income, e.g. medical expenses.
No. 87
Life Risk Types [Specific information – Pillar I – Standard Formula]

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… lapse risk, expenses risk, revision risk and CAT risk.
Lapse risk
The risks of a change in value caused by deviations from the actual rate of
policy lapses from their expected rates.
Expenses risk
The capital charge for expense risk is intended to reflect the uncertainty in
expense parameters as a result of changes in the level, trend or volatility
the expenses incurred.
Revision risk
In the context of the life underwriting risk module, revision risk is intended
to capture the risk of adverse variation of an annuity’s amount, as a result
of an unanticipated revision of the claims process.
CAT risk
The risk that a single event, or series of events, of major magnitude,
usually over a short period (often 72 hours), leads to a significant deviation
in actual claims from the total expected claims.
No. 88
Life Risk Types [Specific information – Pillar I – Standard Formula]

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The health risk module consists of SLT and Non-SLT health underwriting
risk.
Similar to Life Techniques (SLT) Health underwriting risk
SLT Health underwriting risk arises from the underwriting of health
(re)insurance obligations, pursued on a similar technical basis to life
insurance, and is associated with both the perils covered and processes
used in the conduct of the business.
Non-SLT Health underwriting risk
Non-SLT Health underwriting risk arises from the underwriting of health
(re)insurance obligations, not pursued on a similar technical basis to that of
life insurance, following from both the perils covered and processes used in
the conduct of business. Non-SLT Health underwriting risk also includes the
risk resulting from uncertainty included in assumptions about exercise of
policyholder options like renewal or termination options.
No. 89
Health-specific Risk Types [Specific information – Pillar I – Standard Formula]

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Operational risk is the risk that processes, people and systems causes
incidents that lead to losses.
Operational Risk is the risk of a change in value caused by the fact that actual
losses, incurred for inadequate or failed internal processes, people and
systems, or from external events (including legal risk), differ from the
expected losses. Related terms are Business risk, Compliance risk, Expense
risk, Legal risk, Management risk, Model risk, Reputational risk, Strategic
risk.
Operational risks relate to operational loss events caused by internal or
external reasons, excluding all ‘financial’ risks that a company has taken on
in the expectation of a financial return.
Source: CEA /Solvency II CEA Key Messages on Level 2
No. 90
Operational Risk [Specific information – Pillar I – Standard Formula]

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Internal
Model

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No. 92
Overview [Specific information – Pillar I – Internal Model]
Use Test
Governance
Statistical Quality Standards
Profit/Loss Attribution
Validation
Documentation Standards

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One of the main aspects for an undertaking to qualify for an internal model
approach to determine regulatory capital requirements is …
The following elements must be taken into account when assessing the use of
the internal model:
Impact on policyholders
Impact on risk management and use of policies, especially on risk mitigation,
ALM, risk appetite, risk strategy, reinsurance program design, limit system,
analysis of new products
Impact on capital management, capital measurement and allocation
Whether the scale of use of the internal model reflecs the nature, scale and
complexity of the risks inherent to the business of the undertaking
Impact of the level playing field between undertakings
Consistency between supervisory authorities’ decisions
No. 93
Use Test (1/2) [Specific information – Pillar I – Internal Model]

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… that it demonstrates to its supervisory authority that there is sufficient
discipline in its internal model development and application …
There are several approaches that can be considered regarding the assessment
of compliance with the use test:
Detailed list of uses that the undertaking must use the internal model for
Principle-based assessment
Case-by-case analysis of each application
The following areas are highlighted as particularly important within the
undertaking’s system of governance:
System of governance
Risk-management system
Descision-making process
Economic capital assessment
Economic capital allocation
Solvency capital assessment
Solvency capital allocation
No. 94
Use Test (2/2) [Specific information – Pillar I – Internal Model]

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… such that it is widely used and plays an important role in the course of
conducting its regular business, particularly in Risk Management.
Overall requirements for internal-model governance
High-level internal-model governance
Detailed internal-model governance
No. 95
Governance [Specific information – Pillar I – Internal Model]

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With regard to the internal model, some statistical quality standards have
to be hit.
Probability distribution forecast
Requirements for probability distribution forecast
Based on adequate applicable and relevant actuarial and statistical
techniques
Consistent with the methods used to calculate technical provisions
Based upon current and credible information
Based on realistic assumptions
No. 96
Statistical Quality Standards [Specific information – Pillar I – Internal Model]

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An undertaking shall regularly review the source and cause of profit and
loss for each major business unit.
The review of the causes and sources of profits and losses should be geared
to the categorisation of risks.
This will allow the undertaking to demonstrate that the sources are classified
according to the risks the (re)insurance undertaking takes into account and
which reflect the risk profile of the undertaking.
No. 97
Profit/Loss Attribution [Specific information – Pillar I – Internal Model]

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Validation is a set of tools and processes used by the undertaking to gain
confidence over the results, design, workings and other processes within
the internal model.
These tools and processes are both quantitative as well qualitative.
Example of the areas of the internal model that need to be validated must
include at least:
Data
Methods
Assumptions
Expert judgement
Documentation
Systems / IT
Model governance
Use test
No. 98
Validation [Specific information – Pillar I – Internal Model]

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If documentation is not kept timely and up to date, the undertaking is not
protected from key-person risk, which is one of the main reasons that
documentation is held.
The documentation of an internal model shall be thorough, sufficiently,
detailed and complete to satisfy the criterion that an independant
knowledgeable third party could form a sound judgement as to the reliability
of the internal model and could understand the reasoning and the underlying
design and operational details of the internal model.
The documentation must describe the drawbacks and weaknesses of the
model, including the circumstances under which the model does not work
effectively.
No. 99
Documentation Standards [Specific information – Pillar I – Internal Model]

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MCR

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Overall structure
Segmentation of the linear formula
Overall MCR calculation
Quarterly calculation
Linear formula’s components
No. 101
Overview [Specific information – Pillar I – MCR]

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A Linear Formula i.e. a simple factor-based combination of basic volume
measures combined with a cap of 45% and a floor of 25% of the SCR.
A Linear Formula i.e. a simple factor-based combination of basic volume
measures combined with a cap of 45% and a floor of 25% of the SCR
(calculated using either the standard formula or an internal model) to ensure
a proper ladder of supervisory intervention. The cap and the floor together
are the ‘corridor’. In the final step an absolute floor is applied to the result of
the above calculation.
If an undertaking has an approved internal model, then the corridor used for
calculating its MCR is determined by the internal SCR result.
No. 102
Overall structure [Specific information – Pillar I – MCR]

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The MCR linear formula is divided between life activities and non-life
activities. A second split is made between the technical nature of insurance
obligations resulting in four components of the linear formula.
Non-life activities practiced on a non-life
Non-life activities technically similar to life
Life actvities practiced on a life technical basis
Life activities – supplementary obligations practiced on a non-life
technical basis
No. 103
Segmentation of the linear formula (1/3) [Specific information – Pillar I – MCR]

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The MCR parameter of non-life activities is calculated as follows:
1.Non-life activities practiced on a non-life technical basis
should be calculated as the sum over all lines of business of the higher of
the following two results:
a fixed percentage (αlob) of net technical provisions, reflecting
underwriting risk for long-term business
a fixed percentage (βlob) of net written premiums, reflecting
underwriting risk for short-term business
2.Non-life ativities technically similar to life
a fixed percentage (αi) of net technical provisions, at an appropriate
granularity, to reflect long-term risks relating to life business
a fixed percentage of net capital-at-risk (α)
No. 104

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The MCR parameter of life activities is calculated as follows:
3. Life activities practiced on a life technical basis
a fixed percentage (αi) of net technical provisions, at an appropriate
granularity, to reflect long-term risks relating to life business
a fixed percentage of net capital-at-risk (α)
4. Life activities – supplementary obligations practiced on a non-life technical
basis
a fixed precentage (αlob) of net technical provisions, reflecting
underwriting risk for long-term business
a fixed percentage (βlob) of net written premiums, reflecting
underwriting risk foe short-term business
No. 105

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The MCR of an undertaking should be calculated as follows:
MCR = max {MCRcombined: AMCR}
MCRcombined the MCR of the undertaking is i.e. the linear formula result
subject to a floor of 25% and a cap of 45% of the SCR.
AMCR is the absolute floor of the MCR.
The combined MCR of an undertaking is calculated as follows:
MCRcombined = {min[max(MCRlinear;0.25 x (SCR));0,45 x (SCR)]}
MCRlinear is calculated as the sum of four components, whose calculation is
as follows:
MCRlinear = MCRa + MCRb + MCRc + MCRd
No. 106
Overall MCR calculation (1/2) [Specific information – Pillar I – MCR]

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The MCR of an undertaking should be calculated as follows:
MCRlinear = MCRa + MCRb + MCRc + MCRd
MCRa is the linear formula component for non-life business activities on a
non-life technical basis
MCRb is the linear formula component for non-life business activities
technically similar to life
MCRc is the linear formula component for life business activities on a life
technical basis
MCRd is the linear formula component for life business supplementary non-life
activities
No. 107
Overall MCR calculation (2/2) [Specific information – Pillar I – MCR]

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Own Funds

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Basic Own Funds
Ancillary Own Funds
No. 109
Overview [Specific information – Pillar I – Own Funds]

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Raising Own Funds involves issuing capital instruments to investors
(including to an entity within a group) who assume risk in return for yield.
The following features need to be taken in consideration in addition to the
characteristics of permanent availability and subordination:
Sufficient duration
Free from requirements / incentives to redeem the instrument
Absence of mandatory fixed charges
Absence of encumbrances
Tier 1 Own Funds should display the following key features:
Subordination
Loss absorbency
Sufficient duration
Free form requirements or incentives to redeem
Free from mandatory fixed charges
Absence of encumbrances
No. 110
Basic Own Funds [Specific information – Pillar I – Own Funds]

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For classification in Tier 2, ancillary Own Fund items must be callable on
demand to absorb losses on a going-concern basis, as well as in a winding-up.
Ancillary own fund items classified in Tier 2 should be callable own funds of
the highest quality and demonstrably absorb unexpected losses to enable an
undertaking to continue as a going concern.
Hybrid capital instruments and subordinated liabilities, to the extent that they
are classified in Tier 1, would also be classified as Tier 2 ancillary own funds.
No. 111
Ancillary Own Funds [Specific information – Pillar I – Own Funds]
Ancillary fund

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Qualitative
Impact Study
(QIS)

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Lamfalussy Process
Conclusions QIS1
Conclusions QIS2
Conclusions QIS3
Conclusions QIS4
Conclusions QIS5
No. 113
Overview [Specific information – Pillar I – QIS]

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In order to accelerate the EU legislation process... .
Level 1:
The European Commission has drafted, discussed and adapted the Directive
The European Parliament adopted Directive 2009/138/EG of the European
Parliament and the European Council of the 25th November 2009 on the 22nd
April 2009. The European Council has finally adopted it on 10th November
2009. Directive was published on the 17th December 2009 in the Official
Journal of the European Union and came into force on 6th January 2010. It
must be implemented into national law on 31st December 2014.
Level 2:
Based on the directive technical details in the form of implementing Directives
and implementing regulations of the Commission in cooperation with the
market participants and the committees are fixed.
Level 3:
At level 3 work has to be done on implementing provisions and on
specifications of the implementing regulations, defined at level 2. CEIOPS
gives recommendations on interpretations. Common standards are drafted. A
comparison of authorities’ practices takes place. Objective is unified use.
No. 114
Lamfalussy Process (1/2) [Specific information – Pillar I – QIS]

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… the Lamfalussy process has been applied to the whole financial sector
since 2002.
Level 4:
At level 4 the implementation in the member states is monitored by the
European Commission or EFTA.
No. 115
Lamfalussy Process (2/2) [Specific information – Pillar I – QIS]

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QIS 1 focused on the level of prudence in the current technical provisions,
benchmarking them against some predefined confidence levels.
This could give a rough indication of the impact of the proposed rules on the
required provisions.
Due to time constraints and the novelty of the approaches tested, the figures
presented by the undertakings are only an indication.
The best estimate plus risk margin tends to be less than the provisions on
current bases, and that the risk margins tend to be small, for most
undertakings and classes of business.
This impact study also provides a good insight into the methodoCGIl issues
that the requested calculations provide. For life undertakings the calculation
of future bonuses was handled very differently by undertakings, in part
because of differing national regulations.
The stochastic modeling of financial guarantees and the calculation of risk
margins gave problems for a significant number of life undertakings,
nonethless the problems varied with the country. Life undertakings especially
requested more guidance. For non-life the undertakings applied very differing
approaches, though the outcomes tended to be similar nonetheless.
No. 116
Conclusions QIS 1 [Specific information – Pillar I – QIS]

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QIS 2 was about testing a possible methodology so that the results may not
accurately represent the underlying risks.
Using the QIS 2 methodology and parameters, the technical provisions
generally decrease and the capital requirements increase, but the available
capital also increases.
Overall the ratio of available capital to required capital decreases for most life
participants in eleven national markets, but remains above 100%. In another
six the ratio increases for most life undertakings. For a number of life
undertakings the placeholder SCR is near to or even less than zero.
For thirteen national markets all of the majority of the respondents had an
MCR which was less than 75% of the placeholder SCR. For national
supervisors reported a substantial number of participants with an MCR/SCR
ratio of more than 75%.
There is some evidence that, using the QIS2 methodology and parameters,
small undertakings and mutuals may be affected more than large
undertakings and proprietary undertakings.
No. 117

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Some risk modules and correlations seem too be prudent (e.g. market risk,
non-life underwriting risk, size factor).
It is noted that the level of prudence in placeholder and alternative methods
were not always equal.
Concerns were expressed by undertakings in most countries about the high
size of number of the correlations within the market risk component,
particularly those between equities and property, and between equities and
interest-rate.
Several participants noted that the transparancy of the Solvency II process
could be improved by disclosing the rationale for the QIS calibration
assumptions.
It was commented by a number of undertakings that the time period between
the release of the QIS2 technical specification and Excel spreadsheet and the
deadline was too short.
For QIS3, more transparant and user-friendly technical specification,
calibration, and spreadsheets were requested. Additional guidance regarding
practical approximations would be helpful for smaller undertakings.
No. 118

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For QIS3 calculations company accounts were used as a source of inputs,
usually complemented by supervisory reporting and actuarial models for
valuing technical provisions.
The QIS3 spreadsheet provided for a choice to use 2006 or 2005 data. 89%
of submissions were based on 2006, the rest on 2005 figures.
While many participants considered their data to be fairly accurate and
reliable, this view was not fully shared by some supervisors. One supervisor
expressed strong doubts about the reliability after having identified significant
errors in the participants’ calculations and due to the omission of essential
input data. Another supervisor asked participants whether their results would
meet the quality requirements of an annual statement of accounts – about
half of the participating non-life insurers answered this question in the
negative or had reservations regarding parts of their portfolios. In general,
accuracy and reliability are considered to be higher for larger insurance firms
and ‘QIS veterans’ with dedicated actuarial and financial staff.
No. 119

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QIS4 has confirmed the support from industry and supervisors for the
modular structure of the standard formula and would welcome more
tranparency.
QIS4 has confirmed the support from industry and supervisors for the
modular structure of the standard formula for the calculation of the capital
requirements.
This modular structure is composed of different risk modules and sub-modules,
for each of which a capital requirement needs to be calculated.
These modules and sub-modules are then combined through correlation
factors, through which diversification effects are taken into account. As
diversification effects are difficult to calculate, the calibration of the
correlation factors has been subject to many comments.
Undertakings would also welcome more transparency on the calibration of the
various (sub-) modules.
No. 120

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There is broad support both from industry and supervisors towards the
modular approach design in Solvency II.
There is broad support both from industry and supervisors towards the
modular approach design in Solvency II. Also the aggregation approach has
been well received. The system allows, through the use of correlations among
and within the different modules, for the recognition of diversification effects
to acknowledge that all risks cannot materialize simultaneously.
When looking at the correlations tested, and the changes within the
correlations made by CEIOPS as compared to QIS4, very few comments were
received. No major trends could be identified.
In terms of the composition of the SCR, market risk has the highest weight
within the standard formula, particularly for life undertakings (67%). For non-life
the main driver remains the non-life underwriting risk sub-module
(50%).
No. 121

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Governance

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Effective Governance Transparency
Governance Principles
Structural Requirements
No. 123
Overview [Specific information – Pillar II – Governance]

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Effective Governance and Transparency [Specific information – Pillar II – Governance]
Insurer should have an effective governance and a transparent
organizational structure.
Insurer should have an „effective governance in order to allow a
solid and careful business management.“
It „contains an adequate and transparent organisational structure
with clear and segregated responsibilities and an effective system
to provide the information.“
Idea and objective:
Qualitative self-control of the insurers
Source: European Union /DIRECTIVE 2009/138/EC/
No. 124

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Further the undertaking’s system of governance should:
Establish, implement and maintain effective cooperation, internal reporting
and communication
Be robust with a clear and well-defined organisational structure that has well
defined consistent and documented lines within the undertaking
Ensure that important members in the organisation posses sufficient
professional qualifications, knowledge and experience in the relevant areas of
the business
Ensure it employs personnel with the skills, knowledge and expertise
necessary to discharge properly the responsibilities allocated to them
Ensure all personnel are aware of the procedures for the proper discharge of
their responsibilities
Establish, implement and maintain decision-making procedures
Ensure that any performance of multiple tasks by individuals does not and is
not likely to prevent the persons concerned from discharging any particular
function soundly, honestly and professionally
Establish information systems that produce sufficient, reliable, consistent,
timely and relevent information concerning all business activities, the
commitments assumed and the risks to which the undertaking is exposed
Maintain adequate and orderly records of its business and internal
organisation. Safeguard the security, integrity and confidentiality of
information, taking into account the nature of the information in question.
No. 125
Governance principles [Specific information – Pillar II – Governance]

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The SII Directive requires the following structure:
Risk management system [Art. 44]
Compliance: Internal control [Art. 46]
Internal Audit [Art. 47]
Actuarial function [Art. 48] *
No. 126
Structural Requirements (1/2) [Specific information – Pillar II – Governance]

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In more detail risk management and internal control structure requires the
following:
Risk Management System
Underwriting and reserving
Asset-liability management
Investment
Liquidity and concentration risk management
Operational risk management
Reinsurance and other risk-mitigation techniques
Internal Control
A system of effective internal control is a critical component of
undertaking management. Internal control is not a procedure or policy
performed at a certain point in time, but rather a set of continually
operating processes involving the administrative, management or
supervisory body and all levels of personnel.
No. 127
Structural Requirements (2/2) [Specific information – Pillar II – Governance]

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ORSA

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Principles
Requirements
Evaluation Follow-up
No. 129
Overview [Specific information – Pillar II – ORSA]

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ORSA is an essential component of the governance system (pillar 2) of
insurance companies. They shall regularly evaluate their specific risk profile
and solvency status.
‘As part of its risk-management system every insurance undertaking and
reinsurance undertaking shall conduct its Own Risk and Solvency
Assessment.’
Source: European Union /DIRECTIVE 2009/138/EC/ p. 34-35
No. 130
Overview [Specific information – Pillar II – ORSA]

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The ORSA process has to ensure that the process meets the requirements of
Art. 44 (Risk management) of the EU Directive and is also proportionate to
the nature, scale and complexity of its risks.
ORSA should be an integral part of risk management and regularly provide
the overall solvency needs (starting from risk profile, risk tolerance limits,
business strategy)
Assets necessary to cover the liabilities including technical provisions
Regulatory capital requirements MCR and SCR
Internal capital needs
the compliance, on a continuous basis, with the capital requirements (as
well technical reserves)
Assessment of risk profile (if eligible funds cover MCR and SCR on a continuous
basis), e.g. difference between actual capital need and SCR
the significance with which the risk profile of the undertaking concerned
deviates from the assumptions underlying the Solvency Capital
Requirement as laid down
ORSA results must be reported to the national regulatory authority.
Source: CEIOPS /Own Risk and Solvency Assessment (ORSA) 2008/ p. 7-12; European Union /DIRECTIVE 2009/138/EC/ p. 34-35
No. 131
Requirements [Specific information – Pillar II – ORSA]

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The insurer should have regard to the following principles when conducting
its ORSA:
The ORSA is the responsibility of the insurer and should be regularly reviewed
and approved by the insurer’s administrative or management body.
The ORSA should encompass all material risks that may have an impact on
the insurer’s ability to meet its obligations under insurance contracts.
The ORSA should be based on adequate measurement and assessment
processes and form an integral part of the management process and decision
making framework of the insurer.
The ORSA should be forward-looking, taking into account the insurer’s
business plans and projections.
The ORSA process and outcome should be appropriately evidenced and
internally documented as well as independently assessed.
Source: CEIOPS /Own Risk and Solvency Assessment (ORSA) 2008/ p. 13
No. 132
Principles [Specific information – Pillar II – ORSA]

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Guidance items are specifying the principles.
‘The undertaking’s administrative or management body should approve and
regularly review the assumptions, including any management actions, and
parameters used in the ORSA and should also sign-off the results as it has
the ultimate responsibility for the adequacy of the ORSA.’
‘The following risks are examples of risks not considered in the standard
formula, but which should be considered in the ORSA, if they are material for
the undertaking: a) Liquidity risk; b) Reputational risk; c) Strategic risk.’
‘The ORSA should be proportionate in its sophistication and depth to the
nature, scale and complexity of the undertaking’s business.’
‘The assessment should reflect both the undertaking's desire to fulfil its
business objectives and its responsibility to meet liabilities to policyholders.
This means that the ORSA should demonstrate that the undertaking holds
sufficient financial resources to be able to make planned investments and
take on new business (within an appropriate planning horizon).’
‘Documentation should at a minimum include: a) A description of the areas
that are included in the ORSA; b) A description of the process of conducting
the ORSA and the responsibilities of key personnel involved in the process
[…]’
Source: CEIOPS /Own Risk and Solvency Assessment (ORSA) 2008/ p. 14 ff.
No. 133
Guidance Examples [Specific information – Pillar II – ORSA]

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Disclosure

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Report to Supervisor
Solvency and Financial Condition Report
No. 135
Overview [Specific information – Pillar II – Disclosure]

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The Report to Supervisor will contain all the regularly reported information
necessary for the purposes of supervision.
The Report to Supervisor will contain all the regularly reported information
necessary for the purposes of supervision, within a private document sent to
the supervisory authority. This section sets out the envisaged structure,
frequency and contents of the RTS.
The Report to Supervisor is a stand-alone document, which does not require
reference to any other document in order to be understood by the supervisor.
The information should be specifically aimed at the supervisor, including all
elements set out in the SFCR.
Consistent with the structure of the SFCR, the structure of the qualitative RTS
is another area where the proposals from CEIOPS.
No. 136
Report to Supervisor (RTS) [Specific information – Pillar III – Disclosure]

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Solvency and Financial Condition Report (1/2) [Specific information – Pillar III –
Disclosure]
The detail of information to be disclosed should be commensurate with the
nature, scale and complexity of the risks inherent in the business of the
undertaking concerned.
Structure SFCR Business and Performance
Business and external environment
Performance from underwriting activities
Performance from investment activities
Operating / other income and expenses
Any other disclosures
No. 137

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Solvency and Financial Condition Report (2/2) [Specific information – Pillar III –
Disclosure]
The report should comprise:
System of Governance
General governance arrangements
Fit and proper
Risk management system
ORSA
Internal control system
Internal audit function
Actuarial function
Outsourcing
Risk Profile
Regulatory Balance Sheet
Capital Management
Quantitative reporting templates
No. 138

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Pillar 3 reporting requirements [Specific information – Pillar III – Disclosure]
Specifically, the following requirements must be met:
Solvency and Financial
Condition Report (SFCR)
Quantitative
Reporting Templates
(QRT)
Report to Supervisors
(RSR)
Target group Public/ insured Supervisor
public/insured (partly)
Supervisor
Contents • Business and Performance
•Governance system
• Risk profile
• Regulatory Balance Sheet
• Capital management
•MCR
• SCR
• Technical Provisions
• Assets
• Own Funds
• Business and Performance
• Governance system
• Risk profile
• Regulatory Balance Sheet
• Capital Management
Information Quantitative and qualitative Quantitative Quantitative and qualitative
Reporting cycle Yearly Quarterly (supervisor)/
yearly
(supervisor/insured
public)
5 years (complete report)
Source: CEIOPS ’Advice for Level 2 Implementing Measures on Solvency II: Supervisory Reporting and Public Disclosure
Requirements (former Consultation Paper 58), Oct. 2009

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To which stakeholders are reports to be delivered, in which cycles?
How many QRT reports does one have to produces in Solvency II?
What drives the complexity of report generation?
How can we support the client in report generating?
No. 140
Excercises [Specific information – Pillar III – Disclosure]

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Insight into
core S-II
documents

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• Solvency II Directive
Technical Specifications
CEIOPS (EIOPA) Consultation Papers
Annual Reports
Data Reference Model
Solvency II Sales Toolkit
SAS SOREG Solution Spec
No. 142
Core Documents [Specific information – Insights into core S-II documents]

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Solvency II
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