solvency ii: implementation challenges & experiences learned aa - solvency ii.pdf · solvency...

Solvency II:Implementation Challenges & Experiences Learned

Appointed Actuary Symposium

Actuarial Society of Hong Kong (ASHK)

Jonathan Zhao - Actuarial Services Practice Leader, Asia Pacific

3 November 2010

Agenda

► Solvency II introduction & recap

► Implementation procedures

► Experiences & lessons from QIS 5

► Looking ahead

Appointed Actuary Symposium: Actuarial Society of Hong Kong

Solvency II introduction & recap




► Looking ahead


Solvency II introduction & recapBackground

► Solvency II is the proposed new Europe-wide framework for prudential supervision of insurance

► Aims to address problems with Solvency I- Outdated system

- Insufficiently risk-sensitive

- Does not reflect best practice

- Difficulties in supervising multinational, diversified groups

► A fundamental change to Solvency requirements:- Principles based approach to supervision

- Market consistent approach for valuing liabilities

- Capital requirements linked to risk profile

- Convergence of economic capital and regulatory capital

- Major focus on risk management

- Significant disclosure requirements

- Capital add-ons for deficiencies

- Links to other reporting measures


2009 2010 2011 2012

Re

gu

lato

ryti

me

tab

le

Level 2 advice to Commission

L2 drafting (Commission and EIOPC)

QIS5 feedback

European

Member States

IMAP dry run (June 2010 to October 2011)

QIS5May 2009 –Framework DirectiveApproved

Impact study of L2 (Commission)

Legislative

process

Develop guidance under Level 3

IMAP by April 2012 Full implementationInteractive – firms & FSA

CEIOPS/ >EIOPA >

Transposition into domestic law and

regulation

Imp

lem

en

tati

on

act

ivit

y

Build and test

Implementation

EmbedRoad Map

design

Detailed Implementation

design

Vision& Gap

analysis

Implementation –31 December 2012

October 2011 –Level 2 DirectiveApproved

UK

Planning for implementation in 30 countries and associated territories

We a

re

he

re

Solvency II introduction & recap Regulatory timeline and implementation activities

Internal Model Application Process (IMAP) submission


A risk oriented framework

Risk

Quantifications

Risk

Management

Risk

Transparency

Pillar 1

QuantitativeCapital

Requirements

Solvency CapitalRequirements (SCR)

Minimum CapitalRequirements (MCR)

Pillar 2

Supervisory activities

RiskGovernance

Pillar 3

Supervisory reporting& public disclosure

Transparency& Disclosure

Solvency II introduction & recap Frame work – 3 Pillar Approach


Pillar 1

Technical

Provisions

MCR

Minimum

Capital

Requirement

SCR

Solvency

Capital

Requirement

Model

Approval

Risk

Management

Own Risk and

Solvency

Assessment

(ORSA)

Supervisory

powers &

processes

Disclosure-

Solvency &

Financial

Condition

Report

Market

Discipline

Pillar 1 Pillar 3Pillar 2


Solvency II – Pillar 1Market consistent balance sheet

The starting point for Solvency II is an economic, market-consistent approach to the valuation of assets and liabilities. Alignment as far as possible between Solvency II and IFRS 4 Phase II.

Own

Funds

Best estimate liability

Risk margin

MCR

Free

Surplus

Assets

Technical provisions

SCR

Solvency II Balance Sheet

Best estimate liability

Risk margin

MCR

Assets

Technical provisions

SCR

Balance Sheet


► Assets are valued at market value

► Technical provisions = BEL + Risk MarginBest Estimate Liability (BEL)

► Best estimate of all future cash flows discounted at a risk free rate with adjustment for illiquidity premium

► Risk free rate is derived from swap rates less an adjustment for credit risk (10bps), level of illiquidity premium various by contract type (50bps – 100bps)

+ Risk Margin

► Cost of capital method will 6% factor used for QIS 5, IFRS 4 Phase II suggested 3 methods (CI, CTE and CoC)

► Capital requirements► SCR = first regulatory intervention point (VaR @99.5%

CI over 1 year) – Standard Formula or Internal Model

► MCR = final regulatory intervention point

(VaR @85% CI over 1 year)

► Framework directive has also set MCR to a minimum of

25% and a maximum of 45% of the SCR

Solvency II – Pillar I Structure of standard formula for SCR

► SCR intangibles risk module introduced for QIS 5.

► SCR illiquidity premium sub-module introduced for QIS 5.

► Health risk module split between SLT (similar to life techniques) and NonSLT – some reduction in QIS5 for certain correlations between sub-module risks. Health CAT risk introduced (as per Final Advice although the CAT risk is now aggregated across SLT and NonSLT).

► A lapse risk module for Non Life business has been introduced to recognise the impact if policy take-up rates were lower than expected.

AdjOperational

RiskBSCR

= included in the adjustment for the risk mitigating ef fect of future prof it sharing

SLT

Health

Mortality

Longevity

Disability

Morbidity

Lapse

Expenses

Revision

Interest

rate

Equity

Property

Spread

Currency

Con-

centration

Non-SLT

Health

Premium

Reserve

Lapse

Health

CAT Mortality

Longevity

Disability

Morbidity

Lapse

Expenses

Revision

Premium

Reserve

Lapse

Market Health Default Life Non-Life Intangibles

SCR = BSCR + Adj + Op Risk

Illiquidity CAT

CAT

Basic SCR correlations Market Default Life Health Non-Life

Market 1

Default 0.25 1

Life 0.25 0.25 1

Health 0.25 0.25 0.25 1

Non-Life 0.25 0.5 0 0 1


Solvency II - Pillar 2

Technical

Provisions

MCR

Minimum

Capital

Requirement

SCR

Solvency

Capital

Requirement

Model

Approval

Risk

Management

Own Risk and

Solvency

Assessment

(ORSA)

Supervisory

powers &

processes

Disclosure-

Solvency &

Financial

Condition

Report

Market

Discipline



Pillar 2 Requirements

► The key requirement of Pillar 2 is for firms to have a

system of governance to “provide for sound and prudent

management of the business”.

► This system of governance “shall at least include an

adequate transparent organisational structure with a

clear allocation and appropriate segregation of

responsibilities and an effective system for ensuring the

transmission of information”.

► Supporting this requirement are six key “aspects” based

on conditions and functions which the Directive expects

Firms to address and have in place:

Conditions

► Fitness and Propriety

► Outsourcing

► Internal Control

Functions

► Risk Management Function

► Internal Audit Function

► Actuarial Function

Evidencing Successful Pillar 2 Implementation

Governance

► Clear and documented delegation of authority

cascading through the organisation with appropriate

spans of control and suitable persons holding roles

► Suitable allocation of function responsibility that

avoids duplication

► Clear articulation of committee responsibilities split

between “doing” and “oversight” and “assurance”.

► Policies that set out how the business is overseen and

controlled and that reflect the current reality

► Risk information to support individuals and

committees in their roles across the lines of defence

Own Risk and Solvency Assessment (ORSA)

► A demonstrable strategy and appetite for risk that is

cascaded down through the organisation

► A process for identifying all the risks to the business,

quantifying them across a range of outcomes

controlling them and reporting within them within the

governance arrangements set out

► A dynamic approach to using risk information within

the business on a timely basisPillar 2 can be split in two – Governance and ORSA


Pillar 2Own Risk and Solvency Assessment

The ORSA is the regular practice of assessing overall

capital needs with a view to the firm’s specific risk profile

that forms part of the risk management system. It is:

► an internal assessment process and as such should

be embedded in strategic decisions, and

► a supervisory tool for the supervisory authorities.

The ORSA can be defined as the entirety of the processes

and procedures employed to identify, assess, monitor,

manage, and report the short and long term risks that the

business faces or may face and to determine the own funds

necessary to ensure that its overall solvency needs are met

at all times.

The ORSA aims at enhancing awareness of the

interrelationships between the risks the business is

currently exposed to, or may face in the long term, and the

internal capital needs that follow from this risk exposure.

The ORSA needs to be supported by an effective and

robust escalation process paying particular attention to

► Functional escalation

► Risk exposures

and the linkages to decision making

“3 lines of defence” model

– a possible approach to meet Solvency II

requirements

Risk Management Systems

Executive

Committee

Supported

by Risk

Taking

Business

Units

Strategy, risk appetite and policy

Board

1st Line

Risk Ownership

2nd Line

Risk Control and

Monitoring

3rd Line

Independent

Assurance

Own Risk and Solvency Assessment

Audit

Committee

Supported

by Internal

Audit

Internal Control Framework

The ORSA process for assessing and monitoring

overall solvency builds on the Pillar I SCR calculation by articulating the

firm’s view of required capital. It should form an integral part of the

business planning of the organisation. A key challenge will be

integrating the appropriate modelling approaches into the risk

framework and ORSA.

Oversight

Committee

Supported by Compliance,

Actuarial, Risk

Management and Risk

Modelling Functions


Solvency II - Pillar 3

Technical

Provisions

MCR

Minimum

Capital

Requirement

SCR

Solvency

Capital

Requirement

Model Approval

Risk

Management

Own Risk and

Solvency

Assessment

(ORSA)

Supervisory

powers &

processes

Disclosure

- Solvency

& Financial

Condition

Report

Market

Discipline



Pillar 3 Overview

Three aspects:

► RTS and SFCR will contain a qualitative report, including quantitative data and quantitative reporting templates

► Proportionality principle: detail of information is in line with nature, scale and complexity

of risks inherent in the business

► Need a written disclosure policy approved by the management body to ensure

appropriate governance procedures and practices so that information is complete,

consistent and accurate (on an ongoing basis)

► There are provisions to avoid competitors of the undertaking gaining significant undue

advantage – non-disclosure of information in specific cases need to be explicitly

mentioned (along with reasons) in the SFCR

► In the SFCR, you may refer to or make use of equivalent information available

elsewhere in the public domain (although CEIOPS do not consider it appropriate to

refer through hyperlinks to other documents - rather reference if further information is

provided elsewhere)

Disclosures by

regulators

Solvency and Financial condition report - SFCR

Public disclosures – at least annually

Report to Supervisor – RTS

Information to submit to regulator


Implementation procedures




► Looking ahead


2009 2010 2011 2012

QIS5 feedback

IMAP dry run (June 2010 to October 2011)

QIS5May 2009 –Framework DirectiveApproved

IMAP by April 2012 Full implementation

Transposition into domestic law and

regulation

Imp

lem

en

tati

on

act

ivit

y

Build and test

Implementation

EmbedRoad Map

design

Detailed Implementation

plan and activities

Vision& Gap

analysis

Implementation –31 December 2012

Planning for implementation in 30 countries and associated territories

Some key questions regarding your Solvency II implementation

Internal Model Application Process (IMAP) submission


► What level of detail does your implementation plan go to? (e.g., high-level road map and detail activity plan)

► Does your plan build on the output from the gap analysis and identified solutions to mitigate all deficiencies?

► Has your plan been reviewed and approved by the governance committee, with agreed budget, headcounts, and timeline that are realistic?

► What do you plan to do next with your plan?

Key Features

► Horizontal & vertical workstreams

to drive aligned business

requirements and a complete

business case

► Dedicated technical challenge and

support at all levels of the program

► A well defined SII governance/program structure will ensure rapid decision-making, and effective execution of the SII implementation plan

Design Authority TeamProgram Directorate

Program Management Office

Steering Committee

Program Management

Technical Review Panel

Program Governance

Internal Model Optimisation Risk & ORSA Reporting &

Disclosures

Product Pricing

and Development

Process & Controls

Technology/Data and Tools

Documentation

En

ab

ling

Wo

rkstr

ea

ms

Change Management

Workstreams

Illustrative SII governance and program structure –’making it happen’


1512

16

10

42

4

1

2

3

6

3

5

3

1

0

5

10

15

20

25

30

Analyst Senior Analyst Assistant Manager Manager Senior Manager Director

Current team Open positions SII resources required

Resourcing for SII and understanding its implications on existing headcount

SII headcount

means a x%

growth

Considerations on resourcing:

► Where to hire resources from?

► Internal vs. external use of resources and its cost implications?

► Impact on existing headcount and integrating new resources into business as usually activities?

► Speed at which resources can be obtained? Impact on SII programme?

► When do the resources need to be brought it? All at a point in time? Spread over time?


Example of Detailed Road Map – Risk Modelling &

Reporting

5

1H 2010 Business As Usual2H 20121H 20121H 2011 2H 20112H 20102H 2009

SII Reporting Methodology

Overall SII Reporting

Framework

1

2

ALM Modeling 7

10

Define and document required enhancement to models to meet requirements

ESG

Financial Reporting

Infrastructures 9

Ph

ase 1

-

Un

de

rsta

nd

&

Desig

n S

II

Rep

ort

ing

Metr

ics

& M

od

eli

ng

Req

uir

em

en

ts

Ph

ase 2

–S

II

Rep

ort

ing

Imp

lem

en

tati

on

an

d T

esti

ng

Ph

ase 3

-

Tra

ns

itio

n f

rom

Develo

pm

en

t to

Pro

du

cti

on

Economic Scenario Generator (ESG) 4

Validation, documentation &

User Testing

ALM Model 3

Asset Valuation Implementation 6

8

11SII Reporting Full Testing & Dry

Runs

SII Reporting System Go

Live

12

13System launched

Complete QIS5

External Audit Process being Carried OutInternal Finalisation of Models &

External Model Audit

QIS5 Solo delivery by Oct 2010

Implementation of the internal model

Complete design and implement of valuation processes and reporting

Parallel runs of Q1 ~ Q3 2012


Example of Detailed Road Map – Risk Management

1H 2010 Business As Usual2H 20121H 20121H 2011 2H 20112H 20102H 2009

Define and Determine

Risk Appetite

Set Risk Tolerances per

Major Risk Category

Define Independent Review of

ORSA 12

Definition of Risk Appetite

Completed

Allocation of Risk Tolerances per

Major Risk Category Completed

Definition of Independent

Review of ORSA

Completed

Define Management Response to

Risk Identification and Appetite

Definition of Management Response to

Risk Management Completed

Revie

w o

f R

isk

Ap

pe

tite

&

To

lera

nc

e L

imit

s

Build ORSA Report Formats

Rev

iew

of

Go

ve

rna

nc

eR

evie

w o

f O

RS

A

Define and Design Process 8Design of ORSA

Process

Completed

Embed Risk Management

Changes

Build Process

Catalogue

Identify and Assess Operational Risks

Assessment of other Risk categories 10

9Final Documentation of

Operational Risks

Completed

Embedding Change Management Programs Completed

Final Documentation of

Other Risk Categories Completed

Define Control Activities to

Address Risk Management

requirements

Definition of Control Activities

Completed

6

7

5

12

3

4

11

Assess / Update Governance

Manuals, Terms of Reference and Role

Definitions

Annually

review

and

update

as

required

Use Test

13 Use Test Complete


The biggest issue/difficulty faced by company in its Solvency II implementation

► Resource, resource, resource !!!

► Understand the scale and complexity of the SII project and reflecting it realistically in

the time, resource and cost estimate

► Deciding the appropriate detail action plans for both short term and medium to long

term activities, including the key workstream leaders and SII program structure

► Allowing flexibility to cope with surprises arising from the Level 2 Implementing

Measures and Level 3 Guidance

► Allowing for hand-offs and dependencies between workstreams and different

department

► Other


Experiences & lessons from QIS 5




► Looking ahead


Experiences & lessons from QIS 5QIS 5 Overview

Overview

► The final QIS5 Technical Specification was issued on 6 July 2010 after discussions on the Draft Specification with selected stakeholders (CEA, AMICE, CRO Forum, CFO Forum, ECIROA, FERMA and Groupe Consultatif).

► The Commission has emphasized the importance of dealing with all areas of the exercise comprehensively, and is expecting high quality submissions from firms on which to base its decisions.

► A number of key changes from the draft technical spec:

► Changes in calibrations – generally less favourable compared to QIS4, but more favourable compared to CEIOPS Consultation Papers / Final Advice.

► Changes in methodology – additional sub-modules proposed and refinements in methodology for existing (sub)modules compared to QIS4.

► The technical specifications should not be seen as the final outcome as the intention is to publish the Level 2 implementing measures once the results of QIS5 are known.

► Results not required to be submitted to OCI.QIS5 provides an ideal checkpoint for Solvency II programmes to:

► Educate stakeholders with quantitative evidence of the potential impacts, informing lobbying activity.

► Review and realign Solvency II plans based on your experience of performing QIS5.

► Extending the dialogue between local operating companies and European parent.

QIS5 objectives

► To provide detailed information on the quantitative impact of future Level 2 implementing measures .

► To encourage industry preparation and to:

► Identify areas where internal processes, procedures and infrastructure may need to be enhanced and encourage improvements to data collection processes

► To provide a starting point for an ongoing dialogue in preparation for the new supervisory system.


Experiences & lessons from QIS 5 Issues & Challenges - Overview

Key issues and challenges encountered while carrying out QIS 5 exercise:

► Application of contract boundary condition.

► Calculation of expected profits in future premiums (“EPIFP”).

► Calculation of risk margin.

► Severity of standard formula currency risk stress.

► System and resource limitations.


Experiences & lessons from QIS 5 Issues & Challenges – Contract Boundary

► Definition of contract boundary as per QIS 5 Technical Specifications:

► where an undertaking has the unilateral right to terminate the contract; or

► where an undertaking has the unilateral right to reject premiums; or

► where an undertaking has the unilateral right to amend premiums or benefits,

at some point in the future, then any cash flows pertaining to time period after that date should not be included in the liability calculations.

► For insurers in the region, yearly renewable business likely to be affected.

► Likely to affect the BEL negatively as these business tend to have a negative BEL value.

► Current debate on application of contract boundary unit-linked contracts.

► Companies might calculate (submit) two set of results (one follow QIS 5 guidance exactly, and one follow their interpretation) given the definition of contract boundary is unclear


Experiences & lessons from QIS 5 Issues & Challenges – EPIFP Calculation

► QIS 5 introduces the concept of expected profits in future premiums (“EPIFP”).

► Explicit recognition of expected profits built into future cash flows on best estimate basis.

► EPIFP value is to be included as Tier 1 capital for Own Funds calculations.

► Methodology for calculating EPIFP:

► Calculate technical provisions (ex-risk margin) using best estimate assumptions. [A]

► Calculate technical provisions (ex-risk margin) assuming no future premiums are received. [B]

► Technical provision (ex-risk margin) from [B] less that from [A] is the EPIFP value (if negative, EPIFP set to zero).

► In calculating [B], benefit levels are adjusted to be consistent with assumption of no future premiums. This adjustment not trivial as use of retrospectively or prospectively calculated surrender benefits will include elements of past or future profits.

► Severity of issue depend on reliance on EPIFP to meet the required capital requirements.


Experiences & lessons from QIS 5 Issues & Challenges – Risk Margin Calculation

► Recall - risk margin calculation is a cost of capital approach, where the capital is the projected SCR. Projected SCR to include:

► unavoidable market risk;

► life underwriting risk;

► counterparty default risk relating to reinsurance and SPV reinsurance arrangements; and

► operational risk.

► Projection of the SCR requires nested stochastic calculations – stresses to be applied for each future time period.

► Possible modeling solutions being explored include replicating portfolios and formula fitting techniques.

► Meanwhile, QIS 5 technical specifications set out a number of simplifications. Hierarchy of simplifications:

► full calculation of projected required SCR (no simplification used);

► approximate only certain risks in some of the required SCR;

► approximate whole SCR for each future year;

► approximate all future required SCR “at once”;

► approximate risk margin as a percentage of the best estimate liabilities.

► In deciding simplification to be used, need to consider the information, resources and modeling capability available.

► May impact the capital position of the firm as risk margin could be a material value.


Experiences & lessons from QIS 5 Issues & Challenges – Currency Risk Stress

► Standard formula stress for currency stress is an increase and decrease of 25% in net foreign currency exposure.

► This calibration may not be suitable for the Hong Kong dollar /United States dollar relationship given the close relationship of the two currencies in recent history.

► Some participants are viewing this as being too penal.

► Likely to have a significant impact on the SCR calculations.


Experiences & lessons from QIS 5 Issues & Challenges – System and Resource

► System limitations:

► Data systems not able to support the extraction of data at the expected level of granularity required for Solvency II Pillar 1 compliance.

► Example – historical and forecast premium information by line of business.

► Modeling capabilities not sufficiently refined to model key liability and asset portfolio features.

► Example – dynamic policyholder behavior and equivalent scenario.

► Resource limitations:

► Lack of buy-in from management due to submission to OCI not required.

► Possible solutions: educate stakeholders; build relevant Solvency II features into business as usual activities.

► Lack of personnel with the relevant knowledge/experience.

► Possible solutions: tap knowledge of colleagues in European HQ; start recruiting and training now; engage consultants for specific modules.


Looking ahead




► Looking ahead


Looking aheadExpected Implementation Challenges as SII Progress

Use test

► This will be one of the most challenging

areas of the new regime

► The impact will be far reaching and as a

result the implementation challenges will be

significant

Significant business changes

► In the end state of Solvency II, there will be

significant changes to the models,

management information, data, infrastructure

and procedures

► There are commercial and profitability

implications arising out of implementation

Links to other projects

► Solvency II can potentially link directly or

impact on projects already ongoing.

► Ensuring that work done in these

workstreams is leveraged appropriately to

ensure no duplication of effort will be a key

role of the Solvency II Steering Group.

Cultural changes

► Changes in the culture would be required to

reflect new metrics and processes

► There is a necessity to manage the business

to different metrics consistently across the

group…

► …and to reward people on the basis of these

new metrics.

Implementation

challenges


3 September 2009 Training Materials

Looking aheadImpact from IFRS 4 Phase II

3 November 2010

Thank YouAppointed Actuary Symposium

solvency ii: implementation challenges & experiences learned aa - solvency ii.pdf · solvency...

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