Solvency II & Captives

Solvency II

Speakers:• Jonathan Groves, Senior Vice President, Marsh UK

Limited

• Shelby Weldon, Director, Insurance Licensing and Authorisation, Bermuda Monetary Authority

• Vlad Uhmylenko, Director Standard and Poor’s

Moderator:

• Scott Gemmell, Senior Vice President, Marsh’s Captive Solutions Group

Solvency II & Captives

Jonathan GrovesSenior Vice President

Marsh UK Limited

Solvency IIWhat is it trying to do?

Further better regulation by:

• Enhance policyholder protection– Existing rules lack risk sensitivity

• Deepen the single market– Restrictions on proper functioning of the single

market in insurance– Inefficient supervision of groups

• Improve (international) competitiveness of EU insurers– International accounting and regulatory

developments i.e. IFRS Phase 2

Solvency IIWhat is it?

Pillar 1: quantitative requirements

1. Harmonised calculation of technical provisions

2. "Prudent person" approach instead of current quantitative

restrictions

3. Two capital requirements: the Solvency Capital

Requirement (SCR) and the Minimum Capital Requirement (MCR)

Pillar 2: qualitative requirements and

supervision

1. Qualitative requirements to cover

risks which are not captured in the SCR

2. Enhanced internal control, governance, and

risk management + solvency self-

assessment

3. Strengthened supervisory review,

harmonised supervisory standards and practices

Pillar 3: prudential reporting and public

disclosure

1. Common European reporting tools

2. Public disclosure of the financial condition and

solvency report

(market discipline, as participants prefer sound

healthy companies)

Group supervision and cross-sectoral convergence

Comes into effect on October 31, 2012 (but unofficially expected to be January 1, 2013)

Solvency IIWhen is it being implemented?

2010 Omnibus Directive II

CEIOPS: Work on the technical details for implementing measures/supervisory convergence/Level 3 guidance/Binding technical standards

2006 2007 2008 2009 2010 2011 2012

Negotiation & adoption of Directive Proposal

(Council & Parliament)

Implementation preparation(Member States)

QIS 2

July 2007 Directive Proposal

QIS 3QIS 4

April-July 2008

Commission: Preparation of implementing measures

Adoption of implementing

measures

QIS 5August-Nov

2010

November 2009 Directive adopted

Development of Directive

(Commission)

Proportionality principle

Scale

ComplexityNature

Solvency IIProportionality principle

• The Directive should not be too burdensome for small and medium-sized insurance undertakings. One of the tools to acheive that objective is the proper application of the proportionality principle. That principle should apply both to the requirements on the insurance and reinsurance undertakings and on the exercise of supervisory powers (Recital 19, Solvency II Directive)

The impact

Solvency IISpecific treatment of captives

• Framework principles formally define a ‘captive’.

• Guidance from CEIOPS has further defined what will be treated as a captive:– ‘The insurance obligations of an insurance captive undertaking only relate to contracts where all insured

persons and beneficiaries in respect of unexpired risks are legal entities of the group of the captive undertaking and where all insured persons and beneficiaries were legal entities of the group at the time the contract was entered into.

– The reinsurance obligations of a captive undertaking only relate to contracts where all insured persons and beneficiaries of the underlying direct insurance contracts in respect of unexpired risks are legal entities of the group of the captive undertaking and where all insured persons and beneficiaries of the underlying direct insurance contracts were legal entities of the group at the time the contract was entered into.

– The insurance obligations of the direct insurance captive undertaking do not relate to any third party liability insurance.’

• Opt out for captive owners if premium income below EUR5 million per annum– Unclear as to whether can ‘passport’ if opted out

• If not treated as a captive, subject to full effect of Solvency II

What does it mean if…

• You have a captive in the EU– Increased minimum regulatory capital – Increased operational procedures and

accompanying documentation– Increased operational costs– Great disclosure of information into the public

domain

Solvency IIWhat might the market do?

• Exit some risk areas– Axa have already announced they are exiting some life business due

to Solvency II

• Increase price on more volatile risks– Longer tail risks will require more capital to support than has

previously been the case

• Increase fronting charges and collateral– Value of reinsurance provided by companies from non equivalent

jurisdictions discounted within Directive

• Reduce ‘authority’ of underwriters– Potential for model to over ride decisions

• Market consolidation particularly amongst smaller companies

Solvency II & Captives

Shelby WeldonDirector, Insurance Licensing and Authorisation

Bermuda Monetary Authority

Agenda

• Solvency II Regulatory Objectives

• Why seek equivalency

• Bermuda’s preparations and progress to date

• Captive implications

Regulatory Objectives

• Improve the risk management of EU insurers and reinsurers

• Advance supervisory convergence and co-operation

• Encourage cross-sectoral consistency – no regulatory arbitrage

• Introduce proportionate requirements for small undertakings

• Promote international convergence

• Increase transparency

• Ensure efficient supervision of insurance groups and financial conglomerates

Why Equivalency?

OBJECTIVE:

• Compliance with International Standards

• Solvency II most imminent

IMPORTANCE:

• Significant amount of business conducted between Bermuda and European markets

BENEFITS:

• Bermuda (re)insurers can conduct business in Europe on a non-discriminatory basis

• Avoid duplicative regulatory oversight

• Gain access to markets more efficiently due to consistency of supervisory standards

Why Equivalency?

OUR GOAL:

• Broad equivalency with Solvency II by 2012

OUR APPROACH:

• Pragmatic – not to duplicate requirements line-by-line

• Adopt intelligently in line with the nature of the Bermuda market

Solvency II Preparations & Progress

Significant policy work and framework enhancements over the previous two years

• Bermuda Solvency Capital Requirement (“BSCR”)

• Internal Capital Model (‘ICM”) approvals

• Group-Wide Supervision framework

• Supervisory Colleges

• Insurance Code of Conduct

Solvency II Preparations & Progress

Further enhancements in 2010:

• CISSA (Commercial Insurer Solvency Self Assessment)

• Eligible Capital Rules

• Public Disclosure Standards

• Enhanced Solvency Standards for Long-Term Insurers

• Building on supervisory Resources

Solvency II Preparations & Progress

• Bermuda’s framework enhancements are in accordance with the technical requirements of Solvency II as appropriate for the Bermuda market

• Changes focused on commercial sector of the market reinforcing the Authority’s risk-based approach to supervision

Implications for Captives

• Risk-based approach underpinned by the “Proportionality Principle”

• Article 29 of the Solvency II Directive states “Requirements are to be applied in a manner which is proportionate to the nature, scale and complexity of the risk inherent in the business of an insurer”

Implications for Captives

• Bermuda’s captive regime remains consistent with international standards

• Appropriate for the risk profile of companies in sector

• No significant changes at this time

• Actively monitoring and contributing to international developments

Solvency II & Captives

Vlad UhmylenkoDirector

Standard and Poor’s

Systems of Governance (Pillar 2)

Systems:

• Risk Management

• Compliance

• Internal Audit

• Actuarial

Requirements:

• Proportionality– E.g. size, complexity

• “Fit and proper” BoD and mgmt

• Outsourcing– Properly vetted and monitored

• ORSA– Own Risk and Solvency

Assessment

Public Disclosure and Regulatory Reporting Requirements (Pillar 3 )

ORSA: Own Risk and Solvency Assessment

• An internal tool:– Requires (re)insurance enterprises to adequately assess their own

short- and long-term risks– “Own funds” necessary to cover the identified risks and uncertainties

• Methodology used to determine solvency needs

• A tool for the supervisory authorities:– Enables the regulators to evaluate the insurer’s risk profile, risk

management practices, and approach to capital management• Proportionality: a lower bar for smaller/less complex insurers

– Some outsourcing may be allowed– Further guidance needed on the minimum standards

Requirement: Integrated Management of Risks and Capital

Integrated Management of Risks and Capital

Risk Tolerance(s)

Quantification and Aggregation

Risk Limits (& other controls)

Desired Risk Profile

Risk-Vs.-Reward

Case Study: An S&P-Rated Captive Insurer

Rating Criterion Enterprise Risk Mgmt Capital Adequacy

Observations P&C risks of the parent company;

Avoidance of market and credit / counterparty risks

Capital continues to increase (via retained earnings);

No pressure to pay dividends

Conclusions Adequate risk culture and governance; as well as risk controls, risk analytics, and strategic risk management

Redundant capital;

Implicit support from the highly rated parent

Integrated Management of Risks and Capital

Implications for Captives

• Pillar 1 may lead to greater capital requirements

• Pillars 2 and 3 may lead to a greater governance and management burden:– Higher expectations from the Board and the senior management– Formal and more sophisticated risk management

• As of now, few captives are ready for Solvency II

• Solvency II is likely to increase the cost of risks retained via captives

• Potential mitigants:– Principle of proportionality– Bermuda’s captive-specific solvency regime?

Questions