solvency ii news may 2011

8/6/2019 Solvency II News May 2011

1/32

Solvency ii Associationwww.solvency-ii-association.com

Solvency ii Association1200 G Street NW Suite 800 Washington, DC 20005-6705 USA

Tel: 202-449-9750 www.solvency-ii-association.com

Solvency II News, May 2011

Dear Members,EIOPA has a better sense of humor. Below is one interesting slidefrom the official thoughts on the impact of Solvency II:

The same time, companies try hard to find fit and proper riskmanagers, compliance officers and auditors. Fortunately, most actuariesarequalified.

Risk managers experience a massive increase in their take-home pay asa result of the Solvency II projects.

Below is an interesting job description.


2/32


Risk Manager is needed, that will:

1. Provide specialist support to the Risk Team in the delivery of agreedSolvency II development and implementation plans,

2. Embed new or enhanced risk processes and be accountable forassigned project plan deliverables relating to Solvency II processes.

3. Design and execute the risk oversight framework for the InternalModel and supporting processes, including the drafting of oversightreports.

Interesting

Firms continue to lobby, to influence the final implementation of thedirective.

Below there is an interesting example:Lloyd's lobbying

Overview of Lloyd's Solvency II lobbying activitiesWe want Solvency II to recognise Lloyd's unique structure andoperations.

We dont want Solvency II to put the market at a competitivedisadvantage.

For this reason, Lloyds has been and is highly engaged in activity toinfluence the development of Solvency II legislation in Europe,alongside organisations such as the CEA in Brussels and the ABI andthe IUA in London.

It is important for Lloyd's to retain an independent voice in the debate

on Solvency II as well as influencing the input of bodies such as theCEA.


3/32


Although its positions are closely aligned with those of other insurers,there can be subtle, yet important, differences in emphasis and

prioritisation.

Lloyds focus is on the regimes impact on non-life insurers whereassome other major insurers in the UK and Europe are more concernedabout proposals for the treatment of annuities and other issues primarilyof interest to life insurers.

Lloyds also aims to ensure that policymakers in the UK are aware of itsviews.

Lloyds is represented at high-level meetings with the FSA and atministerial level to address key industry concerns regarding Solvency II.

On 5 January 2011, Sean McGovern, Lloyd's Director, sent a letter toManaging Agents' CEOs and FDs with a view to providing an update onthe Lloyd's lobbying approach for the development of Solvency II.

Lloyd's aims

To ensure that:

The Markets unique structure including regulatory recognition as a

unitary organisation is preserved.

The standard formula does not impose excessive capital requirementson undertakings.

Internal model tests, standards and approval processes are reasonableand proportionate.

The types of asset commonly held in the market are appropriatelyrecognised.

Additional administrative burdens on insurers are minimised.


4/32


The competitiveness of the European industry is enhanced, notdiminished.

Also interesting

Many countries continue to work hard to become Solvency II equivalent.Other counties do exactly the opposite. They try to advertise that they

will never become equivalent.Guernsey, for example, the largest captive insurance domicile in Europe,has decided not to seek equivalence under Solvency II.

According to Peter Niven, Chief Executive of Guernsey Finance: Thedecision not to seek equivalence under Solvency II is based on the fact

that under the current proposals, we would need to adopt measures thatmight undermine the competitive nature of our captive insuranceindustry".

Solvency ii Training

The members of the Solvency II Association have a 20% discount for theCertified Solvency ii Professional (CSiiP) and the Certified Solvency iiEquivalence Professional (CSiiEP) instructor-led classes.

Website:www.solvencyiitraining.eu

You may clickRegister after selecting the course location and date.The discount code to enter when registering for a course: sol20
http://www.solvencyiitraining.eu/http://www.solvencyiitraining.eu/http://www.solvencyiitraining.eu/http://www.solvencyiitraining.eu/


5/32



6/32


News - Specifications for the 2011 EU-wide stress test in theinsurance sector

In the second-half of 2009 CEIOPS coordinated an EU wide stress-test

which involved 28 major European insurance groups, including threelarger Swiss insurers.

The scope of the exercise was based on the List of 30 which had beenpreviously agreed by CEIOPS Members.

The stress test was conducted in accordance with the mandate receivedfrom the EFC-FSC with the aim of testing the resilience of the largestand important insurance groups to adverse capital market developments.

The exercise was launched in November 2009 and aggregated resultswere reported by the national regulators to the CEIOPS Secretariat inJanuary 2010.

Aggregated EU-wide results were reported back to EFC-FSC in March2010 and high-level outcomes were disclosed to the public in the samemonth.

For future stress tests the EFC-FSC encouraged CEIOPS and CEBS in2010 to coordinate the timing between the European banking and

insurance stress tests.

The aim of this exercise is to receive information on the currentvulnerability of the EU insurance sector to adverse developments.

At this juncture, priority is given to learning about the economic effectsover implementing a supervisory tool.

This is why the cornerstones of this exercise are most current

information (i.e. year end 2010 data), market valuation, distinct scenarioswith rather different and also contradictory economic developments, andno reference to the current supervisory regime of Solvency I.


7/32


Although not part of the current supervisory toolkit, the insights gainedthrough this stress test will be an input into the supervisory dialoguebetween colleges of supervisors/national supervisory authorities and

participants, insofar as individual vulnerabilities appear too severe totolerate.

As the stress test is not a test of the current regulatory requirements(Solvency I), but uses prospective measures in Solvency II and as muchas possible uses specifications laid out for the last available impactstudy, any results, even when published on an aggregate level, need tobe interpreted with this qualification.

As the stress test is not another QIS5 or a capital requirement and, at thesame time, is based on a yet to be finalised future Solvency II regulation,

the stress test will be conducted on a best effort basis and undertakingsare able to use reasonable approximations, and proxies, where necessary.

In developing the stress scenarios due consideration was given toaligning the macro-economic assumptions with those applied to thestress test in the banking sector.

However, the specificities of the insurance business needed to bereflected in the design of the EIOPA stress test.

EIOPA Regulation Requirements

The new EIOPA regulation which came into force on 1 January 2011enables EIOPA to initiate and coordinate Union-wide stress tests inaccordance with Article 32 to assess the resilience of financialinstitutions, in particular the systemic risk posed by financialinstitutions as referred to in Article 23, to adverse marketdevelopments, and evaluate the potential for systemic risk to increasein situations of stress, ensuring that a consistent methodology isapplied at the national level to such tests and, where appropriate,address a recommendation to the competent authority to correct issuesidentified in the stress test. (Article 21 b)


8/32


9/32


For example, groups and undertakings will be required to hold capital ata level so that they can absorb a significant decline in equity prices -based, as much as possible, on the QIS5-Technical Specifications,although reasonable approximations and proxies may be used, wherenecessary.

In addition to these asset-related stresses, this exercise includesinsurance-related shock scenarios in order to test the resilience of thesector to catastrophic or severe insurance events.

This exercise should also be seen as a precursor for the development of afuture comprehensive stress test framework in accordance with theEIOPA regulation.

Scope of the exercise

The aim of this exercise is to reach a market coverage rate of at least 50%based on statutory gross written premiums per country in EU/EEAmember states, split between life and non-life.

Similar to the previous stress test, the Swiss Financial Market Authority(Finma) has decided to join the Europe wide stress test.

Whilst the market coverage was calculated based on gross written

premiums by solo undertakings, there is not necessarily a need for eachundertaking identified by the national supervisors to carry out a separatestress test.

The exercise should be conducted on the highest level of insuranceconsolidation within the European Union or EEA.

This means that for the purpose of this exercise if these soloundertakings are part of groups which are participating in the stress testexercise, they do not have to submit individual stress test results


10/32


The stress test will thus include more than 200 insurers, including thelargest European insurance groups.

Data collection and analysis

A best-effort principle applies to the 2011 stress test.

This principle has been employed for all QIS exercises or any other ad-hoc data request from EIOPA.

However, given the significantly shorter time-frame set out for this stresstest exercise compared to a full QIS exercise, a reasonable use ofapproximations and proxies is envisaged under this stress test.

In order to ensure consistency and a level playing field, EIOPA offers thepossibility to address open issues in a Q&A procedure.

All participants should register to the related mailing list in order toreceive updates on such Q&As.

All questions and answers will be published on EIOPAs website.

The (lead) supervisors of the respective insurance groups andundertakings will be responsible for co-ordinating the exercise on all

participating companies/groups subject to their supervision.

EIOPA Members should ensure that results are submitted by thegroups/undertakings in a timely manner and they should also validateindividual results, in particular whether these are consistent with the

previous assessments by national supervisors.

Following the collection of data the lead supervisor/national authority isthen expected to submit the anonymised data to EIOPA for processing

the results.


11/32


An example of data to be submitted to EIOPA is shown in Annex 1.EIOPA will provide the lead supervisor/national authority with a basicExcel IT tool to facilitate the delivery of the data.

The information submitted from the lead supervisors/national authorityto EIOPA should also include a qualitative assessment following the

validation process.

Main data to be delivered to EIOPA:

(a) Change and ratio of own funds compared with the MCR perindividual group1/undertaking.

(b) Change in own funds per individual group/undertaking.

(c) Percentage contribution of the individual shocks to the change inown funds per individual group/undertaking.

(d) It is assumed that the political bodies FSC and EFC will receiveindicative and aggregated information at a European level, without anyreference to individual Member States, insurance groups orundertakings.

National supervisors should report aggregated results split between

groups and solo undertakings.

The calculation of the MCR (derived from the SCR) should also beperformed on a best-effort basis, i.e. both SCR and MCR. In order toderive the MCR on a best effort basis participants may, in close co-ordination with their relevant supervisor, include information based onQIS5, if appropriate.

Publication of results

EIOPA will publish the preliminary aggregated results of this exercise inearly July. Due consideration will be given to the Solvency II-framework


12/32


of this exercise, which will make interpretation of results an essentialpart of the analytical output.

This is why EIOPA sees no positive value in a possible publication ofhighly complex individual information, all the more so as the referencebaseSolvency II specifications as in QIS5in itself might undergochanges while this exercise is performed and has indeed already beendiscussed in the preparation for the Solvency II implementing measures.

This being said, EIOPA expects valuable insights into the risk positionof participants for the market in aggregate and for the individualsupervisor to be obtained, as this information is based on fair valuation.

Further, this minimises possibly distorting effects of the Solvency I

framework.

Timeline

March 2011 23 March: Launch of exercise 28 March: Workshop with participating groups/undertakings

May 2011 31 May: Results to be reported to national/lead supervisors

Validation of results by national/lead supervisors

June 2011 14 June: Results to be reported by national supervisors to EIOPA Analysis of results and preparation of aggregate report 30June: Briefing to EIOPA Board of Supervisors and Communication

July 2011 Presentation of results to EFC Presentation of results to ESRB Public presentation of aggregated results


13/32


Reference date

The reference date for all scenarios is 31 December 2010.

Participating groups and undertakings should update the QIS5 results,which were previously submitted to national supervisors, for year-end2010 financials on a best effort basis.

This includes updated discount rate curves to 2010 (both pre and poststress) following a methodology as much as possible similar to the oneused under QIS5, but for simplicity for this exercise assuming no changein the liquidity premiums used, even though the illiquidity premium

would in practice be expected to move in line with the market.

A table is provided by EIOPA as a supplement to this specification.

Participating groups from Switzerland should follow full Swiss regulatoryrequirements (i.e. Swiss Solvency Test).

This stress test model assumes that in the baseline and adverse scenariosthe capital market stresses occur instantaneously and simultaneously onthe reference date.

All other factors or assumptions remain unchanged in relation to the

reference date.

EIOPAs instant stress test model analyzes three what-if-situations orscenarios focusing on development on market prices on bonds, sharesand technical provisions.

An instant model just compares a what-if-situation with thepresentsituation.

This what-if-situation / instant model does not have an explicit timehorizon.


14/32


The scenarios assume a simultaneous occurrence of the shocks for eachcapital market risk factor, so the risk correlation matrix for market andcredit risks is assumed to be 1.

There will be only one set of insurance related stresses for life and non-life across the baseline, adverse and inflation scenarios.

However, a correlation adjustment should be made with other risksfollowing overall Solvency II factors.

Consolidation

Aworld-wide consolidation for participating groups at the highest levelof relevance for the group (including a holding company, if economically

relevant) is required.

Insurance groups should follow the consolidation principles as set out inthe QIS5 Technical Specifications.

For participating solo undertakings, their scope would encompass theiractivities as described below for groups and solo entities.

For simplicity reasons, only insurance activities and other non-bankingparticipations are mandatory for inclusion in the exercise.

Consequently, banking activities are to be excluded from the scope ofconsolidation. If the banking activities are non-material to the groupthey can be included for simplicity.

In case of exclusion from the scope of consolidation, the book value ofbanking participations should be deducted from the available capital.

The value of non-controlled shareholdings in a non-insurance, non-banking subsidiary which is not subject to supervision or capitalrequirements should be included in the equity stress calculation.


15/32


For the purpose of this stress test exercise the QIS5 option of applyinglocal rules for third countries should be included when assessing MCRand available own funds.

Valuation Approach

The previous stress test exercise was based on Insurance GroupDirective (IGD)/Solvency I valuation requirements.

The limitations of this approach, in particular the non-comparabledifferences in valuation standards across Member states, werehighlighted in the stress test results report to the EFC in March 2010.

In order to achieve better comparability and more realistic results, the

2011 stress test exercise will be based on future Solvency II principles.EIOPA acknowledges that there are shortcomings by referring to aframework which is seen as a testing environment and which is bound tochange even whilst conducting this exercise.

However, for the purpose of gaining realistic and consistent information,EIOPA considers QIS5 specifications as being the closest proxy to theframework that should be the background for a stress test.

Although the QIS5Technical Specifications do not represent the final

Solvency II requirements, the application, as much as possible of themost recent Quantitative Impact Study valuation and calculationguidelines overcomes some of the shortcomings of the first exercise.

Conducting a stress test based as much as possible on QIS5 rules willbetter reflect the risk profile of insurance groups and insuranceundertakings thus allowing for better comparability and understandingof outcomes.

However, a reasonable use of approximations and proxies is expected,given the significantly shorter time-frame envisaged for this exercisecompared to a QIS exercise.


16/32


In order to ensure consistency and a level playing field, the principle ofsuch shortcuts should be addressed within the public Q&A procedure.Participating groups and undertakings should therefore as default and,on a best efforts basis, follow the valuation approach as set out in theQIS5Technical Specifications and the QIS5 Q&A document and

which formed the basis for the EIOPA Report on the fifth QuantitativeImpact Study (QIS5) for Solvency II.

Swiss insurers should follow valuation requirements in accordance withthe Swiss Solvency Test.

Stress Test Output

The aim of the stress test is to assess either the group solvency position

or the solvency position of an individual undertaking, focusing on thelevel of own funds (i.e. available capital) before and after the stress testcompared with the Minimum Capital Requirement (MCR) as a SolvencyII measure.

Swiss groups will be assessed based on Swiss Solvency Testrequirements.

The direct output of the stress test will be the reduction in available ownfunds after stress test shocks (scenarios), i.e. own funds as of end-2010

minus the change in own funds after the scenario.

This will be compared to the MCR.

Participants may recalculate the MCR level after the shock in eachscenario, as this would more appropriately represent their solvency

position.

However, for simplicity reasons, the pre-stress MCR will be the defaultnumerator (i.e. in line with the best effort basis participants can opt forleaving the MCR unchanged post stress).


17/32


The output shall include some information on the contribution of thedifferent shocks/risks to the change in own funds.

The Solvency II - MCR is used as a benchmark which is consistent withthe aim of the stress test as it is deemed to be the ultimate interventionthreshold for regulatory purposes whereas a breach of the SCR allows fora more flexible approach.

Swiss insurance groups should calculate their equivalent of the MCR(e.g. Threshold 3 in Circular 2008/44 SST).

EIOPA provides a stress test template in Excel format, comparable toQIS exercises, which will help to minimise misinterpretation of theframework and will produce the expected outcome in a way easily

controllable by participants.

Loss-absorbing capacity

The loss-absorbing capacity of technical provisions and deferred taxescan be taken into account in line with the QIS5TechnicalSpecifications (i.e. that participants exploit the means at their hands only

within the current legal boundaries. See management actions in section16)

For further details please see Section SCR 2 of the QIS5 TechnicalSpecifications.

The loss absorbing capacity should be calculated on a best effort basisusing one of the options outlined in the QIS5 Technical Specifications,but taking into account any legal requirements or restrictions regarding

profit sharing and taxes.

Unit-linked business

In respect of unit-linked business, groups/undertakings should followthe approach as per the QIS5-Technical Specifications.


18/32


Indirect investments

The look through principle as set out in the QIS5-TechnicalSpecification applies to indirect investments.

Hedging

Any existing hedging or other risk mitigations (e.g. derivatives andreinsurance) can be included in the stress testing, but only insofar as thehedging instruments have been in place at the reference date or if thereis a contractual agreement with a counterparty that guarantees adownward protection if predefined capital market scenarios occur.

This also includes dynamic hedging where appropriate.

Where possible, groups/undertakings should report the impact of thehedging on the individual stress test results.

For the inclusion of potential management actions see section 16.

Management actions (post-stress)

In principle, stress test results should be calculated without taking into

account risk mitigating actions (such as closing for new business).

However, groups or undertakings have the option to calculate stress testresults without the impact of management actions (gross) and includingthe impact of management actions (net).

If this option is exercised, both gross and net outcomes would need tobe reported to the national supervisors.

National supervisors will have to verify these management actions and

provide an opinion whether the proposed actions are realistic.


19/32


For the purpose of considering management actions it is assumed thatnegative events occur six months prior to the reference date, so thatgroups and undertakings have time to initiate realistic actions.

However, they should have due regard to the fact that during a period ofcrisis not all proposed initiatives would be successful (such as a fire saleof assets or the implementation of a new hedging programme).

Stress Test Scenarios

This stress test framework comprises the following scenarios andmodules:

For capital market and spread risks there are baseline and adverse

scenarios.

There is also an inflation scenario which assumes an increase in inflationand which forces central banks to rapidly increase interest rates.

In developing the scenarios due consideration was given to aligning themacroeconomic assumptions with those applied to the stress test in thebanking sector, in particular the assumptions underlying themacroeconomic adverse scenario provided by ECB.

The stress test also contains a set of insurance-specific stresses whichare to be applied across the baseline, adverse and inflation scenarios.

All these stresses should be regarded as instantaneous shocks i.e.occurring on the reference date.

Further to these stresses two satellite scenarios on long term low interestrates and sovereign risk are to be conducted.


20/32


Interest rate, equity, property, spread risk parametersInterest rate risk

The ECB macro economic assumptions for market risks in respect of the

development of interest rates reflect an upward trend in the adversescenario.

However, insurers are typically more affected by a decline in interestrates either because of embedded guarantees in life insurance contractsor because of lower investment returns in non-life.

Consequently, the upward stress applied to banks will be used for theinflation scenario and the magnitude of this trend will be converted intoa decline in the adverse scenario.

The floor of interest rate levels post the scenarios is zero.

Equity Risk

The ECB equity market assumptions in respect of the adverse scenarioare very granular within the European Union.

In line with the current proposals under Solvency II and in order tofacilitate the calculation of this stress module, a flat 15% decline for allequities in the adverse and 7.5% for the baseline scenario will beassumed by EIOPA.

Property riskResidential property

In respect of property risk parameters the ECB has provided house priceassumptions for 2011 and 2012 as a percentage deviation from thebaseline scenario.


21/32


EIOPA has used the average percentage deviation for the two years 2011-2012 for the adverse scenario and the 2011 percentage deviation for thebaseline scenario. It follows:

- Baseline scenario: 3.8%

- Adverse scenario: 11.6%

The stresses apply to all residential property world-wide.

Commercial property

Commercial property plays a significant role for insurers? investmentstrategy.

Based on the information available3 the following stresses apply:

- For all commercial property portfolios the decline in property pricesduring 2008 should be considered for the adverse scenario. Based onthis, it assumes a 25% decline for the adverse scenario and a 12.5%decline in the baseline scenario (See table 1 in annex 2).

The stresses apply to all commercial property world-wide.

Spread risk

A 31.4% shock for investment grade bonds and a 38.3% shock for highyield bonds have been assumed.This has been converted from actual option adjusted spreads (based onMerrill Lynch Bond indices as of 31 December 2010) applying anadditional increase to actual spreads for investment grade.


22/32


23/32


that we still do not have full clarity on what has to be in place for dayone.

We have made some assumptions, and we keep the position underreview.

What I will be saying to you today is based on our current view of theworld, particularly that there will be full implementation on 1 January2013.

If this should changealthough I should stress that we have noinformation at present that it willwe will naturally review our plans andmay look again at our implementation approach.

We would clearly expect firms to do the same.

Our current plans recognise Solvency II as a significant challenge, butone which both we and the UK industry are in a good position to meet.

This is becausewe view Solvency II as an evolution of the regime whichwe have had in place here in the UK for a number of years, and we havefought very hard in Europe to ensure that many of the principles whichunderpin the current UK approach are present in the Solvency II regime.

We also have a long-standing knowledge base of the firms we supervise,and we recognise that we are not starting from scratch when we come toreview many aspects of firms activities.

Nonetheless, there are significant changes which both we and firmsneed to make to ensure that implementation is a success.

The Directive brings about entirely new areas of responsibility for us, notleast a significantly enhanced group supervision regime, and provisionfor model approval.


24/32


These new responsibilities, along with the changes we need to make toother parts of what we do, mean that implementation of Solvency II isthe largest programme of its type ever undertaken by the FSA.

This is partly because Solvency II is not only a new Directive which wehave to implement, but is also something which will influencesignificantly the shape of, and approach to, insurance supervision in thePrudential Regulation Authority (PRA) when it is created.

The PRA is due to assume its statutory responsibilities in early 2013, ataround the same time as the implementation of Solvency II, andas webuild the new regulatorwe will be embedding Solvency II in all that itdoes, whilst preserving the best of the FSAs existing approach.

One of the main reasons for our programme of work being so substantialis that we have a large and vibrant insurance market here in the UK, witha greater number of firms than in many other Member States.

On top of this, firms have shown a very significant level of appetite forthe use of internal models, possibly driven by the UK industrys priorexperience of modelling under the ICAS regime, but also probablydriven by two specific aspects of the UK market.

Here in the UK, firms write significantly higher levels of with-profits

business than elsewhere in Europe, and this lends itself much more to aninternal model approach.

The same is true of the international catastrophe and specialist businesswritten in the London market.

All of these features mean that we have seen a large number of firmsentering our pre-application process.

I want to be clear here thatwe do not necessarily regard developing a full

model as being the only acceptable choice; nor do we necessarily regarduse of the standard formula as being in some way second best.


25/32


Whatever its deficiencies in some areas, the standard formula producesfor some firms perfectly acceptable results, and we would expect firms toconsider use of the standard formula for some risk modules, or some

parts of their business.

Nevertheless, the number of firms developing an internal model issignificant, and I therefore propose to spend some time in a momenttalking about our internal model approvals processgenerally known asIMAP.

Before I do so, I want to touch first on some other aspects of Solvency IIwhich have received a little less airtime so far, but are just as importantand not optionalreporting and ORSA.

First of all, Solvency II will bring about very significant changes to thereporting regime for all firms, whether they are using a model or not.

From a regulatory perspective this is a considerable enhancement in thequality of the data we will receive, and in the way it is submitted to usand shared amongst supervisors across Europe.

For the first time, all European supervisors will be receiving data fromfirms on a consistent, comparable and shareable basis.

For firms, the new reporting regime will require changes to systems, andwe will be requiring all firms to submit quarterly reports during 2013, andannual reports in respect of their 2013 year end.

The UK-specific aspects of the reporting regime will be covered in ourconsultation process, and firms should engage fully with it both at thattime and before via the Association of British Insurers (ABI) and ourindustry groups.

Solvency II also requires all firms to have sound governance, good

internal controls and effective risk management across the whole of thebusiness, not just the financial areas.


26/32


All firms are subject also to the requirement to have in place an OwnRisk and Solvency Assessment processthe ORSA.

This is the principal means by which Solvency II draws together riskmanagement, governance, controls and capital into a single picture

which is squarely the responsibility of firms senior management andwhich must be used in decision making.

Firms should ensure that all of these aspects of their business arecompatible with Solvency II requirements, and that they have in placethe processes to ensure that they can manage the ORSA successfully.

So, Solvency II is not just about capital requirements, and is not justabout internal models.

Nonetheless, our IMAP approach is something that I want to turn tonow.

As responsible custodians of funds which we raise from you, theindustry, we have to be sure that, when organising such a large

programme of work, we are in a position to deliver it safely and ensurethat those funds are properly deployed to the best effect.

This is the approach we adopt in all of our work, and you will be familiar

with the risk-based approach we have always taken to the allocation ofour resources.

Given all of the constraints I have already talked about, we have lookedagain at our ability to deliver the IMAP process, along with everythingelse we are preparing to do before day one.

We have considered the level of resources we are able to devote to firmsgoing through the pre-application phase of IMAP, and have decided toconcentrate these on a smaller population of firmsthose firms

representing a significant market share, and being those which we have


27/32


always regarded as having the highest potential impact on ourobjectives.

These firms will continue to receive the greatest intensity of reviewthroughout the pre-application phase, with detailed reviews of variousaspects of their model in accordance with a work plan which we willagree over the course of the coming weeks.

Specifically, these firms comprise the following sets: major UK life andnon-life firmsbroadly the UK top ten; firms which have operations inthe Lloyds market; and firms which are subsidiaries of major Europeangroups where we will be obliged to participate in a college ofsupervisors.

Other firms who are in pre-application will receive a reduced level ofengagement.

This will comprise a small degree of interaction with our actuaries andother risk specialists, supplemented as always by interactions withsupervisors to ensure that firms remain on-track with their plans.

We are proposing to develop various tools to facilitate our review.

We think a number of these will assist firms in ensuring that their model

development continues in the right direction and will help bridge thegap created by the reduced specialist input.

The following are some examples of the kind of tools we are developing:

1. Stress testing for general insurance firms;

2. Reference portfolios to test model treatment of certain types of asset orbusiness;

3. Industry standards on catastrophe models; and


28/32


4. Specified models for certain esoteric types of firm.

More details on how these will work and the kind of firms to which wellbe applying them will follow at a later date.

We will be working with the ABI and others to ensure that we achieve asolution which meets our needs whilst not imposing undue additionalburdens on industry.

At the same time, we will be introducing elements of external review intoour approach, whereby we will allow firms to submit to us independentreports on some aspects of their model and how it works.

The advantage of this approach is that firms get to see up front the areas

in which we are particularly interested, and the FSA will receiveindependent reviews in a consistent format, which will help us to takedecisions quickly and efficiently.

We will be piloting this approach in the area of data very soon, and moredetails will follow later in the summer.

This lower level of specific specialist interaction for some firms shouldnot be taken to mean that those firms will in some ways be held to lowerstandards than others.

The Directive is clear that the same standards apply to all firms, and thatis how we will implement it.

We are merely being proportionate here in how we apply our internalresources to our investigations as to whether those standards are beingmet; and being proportionate in the level of engagement we are able togive to firms in the run-up to implementation.

I should also make it clear at this point that pre-application is now

closed.


29/32


This means that no more firms will be able to enter the pre-applicationprocess, which in turn means that firms which are currently not in pre-application should not expect to receive a pre-day one decision on aninternal model, and they should therefore plan accordingly if they are notalready doing so.

Supervisors are aware of the approach which is being taken forindividual firms, and will be able to let you know soon what the work

plan for your firm will look like, and the level of interaction you are likelyto receive.

It would be useful also to highlight what this approach means and doesnot mean.

First, being in pre-application does not guarantee a firm day-oneapproval of its model; it simply means that we are striving to be in aposition to make a decision on that internal model application prior today one.

We cannot guarantee to be in a position to make a decision, as in partthat depends on the quality and completeness of the application wereceive.

Second, the reduced level of attention devoted to some firms which I

mentioned a few moments ago does not necessarily imply that thosefirms are less likely to have a decision prior to day one.

By and large, the firms where we are applying our resources are thelargest and most complex, and therefore those for whom the challenge ofbuilding and implementing a model will be the greatest.

It is also important to stress that the FSA cannot make decisions aboutgroup internal model applications in isolation, as our ability to make adecision will rely on other supervisors agreement and engagement

through pre-application and beyond, which is outside our control.


30/32


We have also reviewed and streamlined our processes to ensure that wemake maximum use of the knowledge our supervisors already haveabout the firms that they supervise, and to ensure that we focus on thekey judgements of maximum impact, making sure we get the mostbang for our buck.

Firms will begin to see the benefits of this approach as we agree workplans and move into the next stage of pre-application.

Whatever approach is taken to pre-application, the objective is for a firmto reach a point where it is able to submit a full application to us formodel approval.

Exactly what we look at after receiving this application will depend on

the level of interaction we have had so far, and the extent to which firmshave responded to the feedback we have given them previously, so theapproach will be an individual one for each firm.

What I can tell you today is that we will be open to receive thoseapplications from 30 March 2012.

This is later than we had originally envisaged, and reflects thedependency we all have on the EU policymaking process, and our needto be sure that we have as much clarity as we can on the policy position

and the requirements which we are expected to meet, both in our ownoperations and in the firms which we supervise.

We currently envisage remaining open to receive formal applications fortwo months, meaning that any firm currently planning to submit aformal application later than the end of May next year is unlikely toreceive a decision before day one.

Firms should be aware that our processes will be designed with regularreview points, both during pre-application and after formal applications

are received.


31/32


If at any of these points we feel that a firm is likely not to be able to meetthe required standards in time, we will be inviting firms to leave the

process and invoke their contingency plans at these checkpoints alongthe way.

As well as ensuring transparency and fairness for the firms involved, thiswill allow us to conserve our resources and focus them on those firmswhich have the best prospects of achieving model approval.

There are three possible outcomes of the model approval process:

1. Firms may have their models fully approved;

2. They may have them partially approved; or, in a small number of

cases,

3. They may be rejected altogether, either because the application isincomplete, or because our review work continues to point to significant

weaknesses.

Two out of these three outcomes will require firms to have a contingencyplan to fall back on, and I have alluded to this a number of times already.

This therefore seems an appropriate time to spell out in a little more

detail what those contingency plans might be.

Firms will be aware that non-approval of a model application means thatthey revert to the default position under the Directive, which is to use thestandard formula.

This would apply either to the firms whole business (in the case of acomplete rejection of the model) or to those parts not covered by theapproved elements of a partial model.

That is not quite as simple as it sounds because, where firms are usingthe standard formula, they have a responsibility to assess its suitability,


32/32


and to be confident that it properly reflects the risks inherent in theirbusinessthis should be reflected in their ORSA.

All firmswhether they are planning to use the standard formula, orbecause the standard formula is part of their contingency planningshould therefore take accountat the very leastof the extent to whichthis is the case, and the areas in which firms would need to make use ofundertaking specific parameters, or other adjustments to the basicstandard formula.

Firms should also give consideration to the extent to which use of thestandard formula would imply a much higher regulatory capitalrequirement than their own model, and explain to us what theirapproach would be to meeting those additional capital requirements,

given that our decision on whether or not to approve their model wouldpotentially come much later in the day.

I have attempted here to set out some of the immediate, major changesto our approach which will become visible to you in the coming weeksand months.

solvency ii news may 2011

Documents