Solvency II in a nutshell pwc PDF

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Solvency II in a nutshell...

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Solvency II in a nutshell General overview

Current solvency regime Solvency I

Quantitative requirements • Available solvency capital • Minimum capital requirement • Simple and uniform calculation with no connection to the risk exposure • Very limited calculation and reporting cost • Direct link to the statutory reporting

Solvency II PwC

10.11.2015.

Future: 3 pillars Solvency II Pillar 1 Quantitative Requirements

Pillar 2 Governance and Supervisory Review

• Market consistent evaluation of assets and liabilities in a specific balance sheet

• Corporate governance

• Solvency capital requirement (SCR):

• Own risk and solvency

• Internal controls and

sound risk management assessment (ORSA)

− Standard formula

• Rules on supervision

− Internal model

• Supervisory intervention

• Minimal capital requirement (MCR)

• Solo and group

Pillar 3 Disclosure Requirements • Outside communication of

the outcomes of two other pillars • Public and private (for

supervisory) reports • Narrative reports

(SFCR and RSR) • Quantitative reports

(Annual and quarterly QRTs)

• Own funds and their tiers • Solo and group approach Solvency II PwC

10.11.2015.

Solvency II framework - an integrated perspective Approval process & supervisory dialogue Supervisory reporting & public disclosure Processes, controls, data & IT Governance & risk framework Process organization SFCR RSR

Process and IT landscape

Organization Functions

Capital requirements

Fit & Proper Calculate SCR and MCR

QRT

Use of Internal Modells

Calculate SCR on group level

Risk strategy Data quality Data policy dates and deadlines

Data security

ORSA Capitalallocation Limit system Risk management process

Solvency balance sheet & own funds

Own funds

Valuation assets, & liabilities

Risk reporting

Business strategy, business management Solvency II PwC

10.11.2015.

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Capital evaluation (Pillar 1)

Agenda

The Solvency II balance sheet

1 Solvency II PwC

Solvency capital requirement

2 10.11.2015.

The Solvency II balance sheet

Solvency II PwC

10.11.2015.

3 pillars Solvency II Pillar 1 Quantitative Requirements

Pillar 2 Governance and Supervisory Review

• Market consistent evaluation of assets and liabilities in a specific balance sheet

• Corporate governance

• Solvency capital requirement (SCR):

• Own risk and solvency

• Internal controls and

sound risk management assessment (ORSA)

− Standard formula

• Rules on supervision

− Internal model

• Supervisory intervention

• Minimal capital requirement (MCR)

• Solo and group

Pillar 3 Disclosure Requirements • Outside communication of

the outcomes of two other pillars • Public and private (for

supervisory) reports • Narrative reports

(SFCR and RSR) • Quantitative reports

(Annual and quarterly QRTs)

• Own funds and their tiers • Solo and group approach Solvency II PwC

10.11.2015.

Solvency II Balance Sheet Market-consistent approach Ancillary own funds

Off-balance sheet items

SCR Own funds

MCR

Risk margin for non-hedgeable risks Best Estimate Assets Economic value

Technical provisions

market-consistent valuation for hedgeable risks

Solvency II PwC

10.11.2015.

Valuation of technical provision Amount a reference undertaking is expected to need to accept and cover underlying (re)insurance obligations Valuation as a whole Market-consistent valuation as a whole, if the provisions can be replicated by financial instruments Criteria: • Any uncertainty regarding the amount and length of the obligations is to be reliably replicated • Financial instruments shall have reliable market values

Risk margin • (Risk) amount required for the insurance portfolio to be transferred to a reference undertaking for the term • Calculated with weighted average cost of capital

Best estimate • Probability-weighted average of future cash flows based on the current value of the money and yield curve • Including options and guarantees

Segment into homogenous risk groups, as a minimum by lines of business, as defined by the EIOPA Definition of insurance contracts: Examples of contractual limits that do not belong to the insurance contract: the insurer‘s unilateral right of notice; insurer‘s right to adjust premiums according to risk; obligations resulting from future premium income where the insurance benefit does not include financial guarantees

Solvency II PwC

10.11.2015.

fair value structure

Recognition and Valuation Principles Assets and other Liabilities 1

Mark-to-market: quoted prices in active markets

2

Marking-to-market: quoted prices in active markets for similar assets and liabilities with adjustments to reflect the differences

3

Marking-to-model: Alternative valuation methods; with maximum use of relevant market inputs and rely as little as possible on undertaking specific parameters

Economic approach: Valued with the amount for which the assets/ liabilities could be exchanged / settled between knowledgeable, willing parties in an arm’s length transaction. Active market:  

Quoted prices are readily and regularly available Actual and regularly occurring market transactions on an arm’s length basis

Solvency II PwC

10.11.2015.

IFRS vs. Solvency II Summary of main differences – Assets (1) Area

IFRS

Solvency II

Significance

Observations

Goodwill

Cost less impairment

Nil



• Goodwill is not considered to have an economic value for Solvency II

Intangible assets

Cost or fair value less depreciation /impairment

Generally nil



• Intangible assets can be recognised at IFRS valuation only where they are separable and there is an active market. This is unlikely in practice.

PPE

Cost or revaluation

Revaluation



• Cost option is not available for Solvency II

Finance leases

Lower of fair value and present value

Fair value



• Finance lease assets should be valued at fair value • Use of depreciated cost is not permitted • The initial valuation of finance lease assets by lessees differs form the approach under IFRS

Investment property

Cost or revaluation

Revaluation



• Cost option is not available for Solvency II

Participations in subsidiaries, associates & JVs

Cost or fair value, unless held for sale

Market price, adjusted equity, mark to model, or nil



• Valuation of participations may be significantly different under Solvency II.

Solvency II PwC

10.11.2015.

IFRS vs. Solvency II Summary of main differences – Assets (2) Area

IFRS

Solvency II

Financial assets

Amortised cost or fair value

Fair value



• Amortised cost option is not available

Deferred tax assets

Temporary difference * tax rate

As for IFRS but using SII valuation



• The principles for calculating deferred tax are the same but the Solvency II balance sheet valuations must be used

Non-current assets held for sale or discontinued operations

Lower of carrying amount and fair value less costs to sell

Fair value less costs to sell



• Option for a different carrying amount is not available

Current tax asset

Amount expected to be recovered

Amount expected to be recovered



• No difference in valuation

Off balance sheet financing

Not recognised

Recognised where approved



• Off balance sheet financing may be approved as ancillary own funds and recognised on the Solvency II balance sheet

Solvency II PwC

Significance

Observations

10.11.2015.

IFRS vs. Solvency II Summary of main differences – Other liabilities Area

IFRS

Solvency II

Financial liabilities

Amortised cost or fair value

Fair value with no revaluation for own credit standing



• Amortised cost is not available for Solvency II, and Solvency II valuation should not reflect changes in the insurer’s own credit standing

Provisions

Best estimate where probable

Best estimate



• All liabilities are recognised under Solvency II, even where they are currently considered contingent liabilities under IFRS

Deferred tax liabilities

Temporary difference * tax rate

As for IFRS but using SII valuation



• The principles for calculating deferred tax are the same but the Solvency II balance sheet valuations must be used

Current tax liabilities

Amount expected to be paid

Amount expected to be paid



• No difference in valuation

Employee benefits

Valued under IAS19

As for IFRS



• Valued in accordance with IAS19

All other liabilities

Various valuation rules

As for IFRS



• For all liabilities where there is no specific valuation rule for Solvency II, the IFRS valuation is used

Solvency II PwC

Significance

Observations

10.11.2015.

Own funds Step 2 Classify own-fund items into “tiers” on the basis of the type of own funds and the following six criteria

Step 1 Determine on/off balance sheet available own funds Available own funds =

Ancillary own funds

Basic own funds

Assets –

• • • • • •

Subordination Loss absorbency No incentives to redeem No fixed maturity No mandatory servicing costs No encumbrances

Quality

Basic OF

Ancillary OF

High

Tier 1

Tier 2

Mid

Tier 2

Tier 3

Low

Tier 3

Liabilities + Subordinated Liabilities + Other funds available to absorb losses

Step 3 Eligible amounts of tier 2 and tier 3 items subject to quantitative limits Minimum limit Tier 1

Tier 2

Maximum limit Tier 3

Additional requirements for groups: • Own-fund item can, due to legal or regulatory requirements, absorb the losses of another entity in the group (fungibility) • Own-fund item can, due to legal or regulatory requirements, be transferred to another entity in the group (transferability) • Own-fund item must be available for another entity in the group within 9 months

Solvency II PwC

10.11.2015.

How mature is your Solvency II balance sheet? Infancy Most firms have… • • • • •

Scoping: identified the areas of the balance sheet which are most judgmental or difficult Methodology: performed detailed analysis on individual adjustments to determine methodology and approach Initial Calculation: calculated a summary Solvency II balance sheet at least twice Reconciled: performed a high level reconciliation between their GAAP and Solvency II balance sheets Review: presented and discussed the balance sheet with the board/other relevant governance committees

Market average ...many haven’t …. • Reduced unnecessary estimates: considered where estimation is appropriate, and where it is not – And differentiated between the short and long term • Non insurance valuation: analysed the less obvious areas – E.g. tax • Own Funds: really understood the components of Own Funds, what options this provides, or how calculated in a group situation • Detailed data: formally decided at what ‘level’ they are going to make Solvency II adjustments (which could differ by area) • Best estimate: considered if their Solvency II best estimate contradicts GAAP reserving assumptions/policy • BAU: thought about how the Solvency II Balance Sheet production becomes an ‘as usual’ process • Infrastructure: started building the reporting infrastructure to support ongoing production – E.g. a Solvency II general ledger • Economic profits and losses: really understood the economic movements from period to period inferrred by the Solvency II balance sheet and reconciled the Solvency II economic profit or loss to GAAP • Financial control: extended their financial control framework to cover the Solvency II balance sheet • Assurance: gained assurance over their Solvency II balance sheet from external auditors/Parties (both controls and results) Almost none have… Maturity • Confidence: got the same confidence in Solvency II as they do in their GAAP results Solvency II PwC

10.11.2015.

Solvency Capital Requirement

Solvency II PwC

10.11.2015.

Solvency II Balance Sheet Market-consistent approach Off-balance sheet items

Ancillary own funds

SCR Own funds

MCR

Risk margin for non-hedgeable risks Best Estimate Assets Economic value

Technical provisions

market-consistent valuation for hedgeable risks

Solvency II PwC

10.11.2015.

Supervisory dialogue/actions Case 1

Case 2

Case 3

SCR MCR • No sanctions • Regular reviews

Capital requirements

Solvency II PwC

Sanctions: • Establish a realistic recovery plan and progress report • Increase own funds • Reduce risk profile • Restriction/prohibition of previously allowed free disposal of assets • Capital add-on

Sanctions: • Development of a short-term realistic finance scheme to increase at least to the level of the MCR • Prohibition of free disposal of assets • Withdrawal of authorisation

Own funds

10.11.2015.

Solvency capital requirement (SCR) 0,25

SII confidence level (99,5%)

Best estimate (50%) 0,2

0,15

0,1

0,05

0 0

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

SCR Solvency II PwC

10.11.2015.

Requirements for (partial) internal models There are several methods to calculate the SCR Partial and full internal models require prior approval by the regulator

Risk sensitivity

Full internal model

Partial internal model Standard formula with undertakingspecific parameters (USPs) Undertaking-specific parameters require approval by the regulator

Standard formula Standard formula with simplifications

Use of a (partial) internal model for calculation purposes • One or more risk modules or sub modules • Capital requirement for operational risk • For whole business or one or several major business units • Adjustment for the loss-absorbing capacity of technical provisions and deferred taxes

Complexity

Solvency II PwC

10.11.2015.

Structure of the Standard formula Modular design SCR

Adjustments

Market

BSCR

CDR

Health

operational

Life

Intangible Assets

Non-life

SCR

Currency

SLT Health

Property

Mortality

Interest rate

Longevity

Non-SLT Health

CAT

Mortality

Premium Reserve

Longevity

Lapse

Disability Morbidity

Equity

Disability Morbidity

Lapse

Spread

Lapse

Expenses

Concentration

Expenses Revision

Revision

Premium Reserve

Lapse CAT

= Adjustment for the lossabsorbing capacity of technical provisions

CAT

*EIOPA suggested to replace CCP by a “volatility balancer” Solvency II PwC

10.11.2015.

Solvency Capital Requirement calculation

Assumptions for SCR calculation

SCR calculation

• Going-concern basis

• Assignment of capital market instruments, insurance contracts, counterparties, etc. to risk modules • Calculation of risk capital per module • Aggregation of individual risk capital charges using a correlation matrix

• Calibration to ensure that all quantifiable risks are considered • Risk measure: Value-at-Risk with confidence level of 99.5% over the one-year horizon • Consideration of risk-mitigation techniques, provided that credit and other risk related to such techniques are appropriately reflected in the SCR • Calculate and report results to the Supervisory Authority at least annually • In case of change in risk profile: the Supervisory Authority can demand recalculation of SCR • Calculation of SCR for investment vehicles, mutual funds and other indirect investments which are not affiliated companies is based on the individual target investments (look-through approach)

Solvency II PwC

• BSCR = √∑  ·     ij

• Adjustment: consideration of risk mitigation effect of future profit sharing and deferred taxes → Calculation of SCRGross and SCRNet

10.11.2015.

Basic Solvency Capital Requirements (BSCR) Calculation with correlation matrix The six types of risks should be combined to an overall “Basic SCR” using a correlation matrix for market, life, health, non-life and default risk

Corr BSCR

SCRMarket

SCRdefault

SCRlife

SCRhealth

SCRMarket

1

SCRdefault

0.25

1

SCRlife

0.25

0.25

1

SCRhealth

0.25

0.25

0.25

1

SCRnon-life

0.25

0.5

0

0

Solvency II PwC

SCRnon-life

1 10.11.2015.

Delta NAV Approach Calculation of capital requirements of sub-modules using shock scenarios Example Longevity Shock (decrease of 20%) Solvency II balance sheet before shock

Solvency II balance sheet after shock

NAVnew
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