Solvency II update. Shirley Beglinger Shires Partnership Ltd Global Association of Risk Professionals. December 2014

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1 Solvency II update Shirley Beglinger Shires Partnership Ltd Global Association of Risk Professionals December 2014

2 The views expressed in the following material are the author s and do not necessarily represent the views of the Global Association of Risk Professionals (GARP), its Membership or its Management. 2

3 A rocket-powered prudential regime for the 21 st Century From 2015, companies and groups must calculate their solvency capital requirement, taking into accoun Diversification in the portfolio or group Reinsurance Hedges Reserve adequacy from year to year Companies are encouraged to develop their own internal models for the calculation Global Association of Risk Professionals. All rights reserved.

4 More than actuarial number-crunching Pillar I Pillar 2 Pillar 3 (Numbers) (Governance) (Transparency) Eligible Capital Technical provisions Investment capital requirement Risk dependencies Risk measures & assumptions Calculation formula Internal model approach Own Risk & Solvency Assessment - ORSA Use Test Internal controls Risk management Risk appetite Risk mitigation Stress testing Continuity testing Regulatory reporting IFRS from 2016 Corporate risk appetite statement Demonstrating adequate resources Governance & Regulatory Supervision Public Disclosure & Regulatory Reporting Global Association of Risk Professionals. All rights reserved.

5 SCR Build-Up Third party failure to pay debts Investment failure risk (new) Underwriting SCR + Counterparty Credit SCR + Market SCR + Liquidity SCR = Base SCR = + Underwriting Risk + Reserve Risk Approx. 2/3 of the loading Volume affects the charge Reserve volatility and reserving policy influence the charge OP. Risk SCR = Total SCR Global Association of Risk Professionals. All rights reserved.

6 Solvency 2: What counts as eligible capital Tier 1 Permanent share capital Retained profits Positive valuation differences Perpetual non-cumulative preference shares Innovative Tier 1 structures (probably not more than 10%). Tier 2 Perpetual cumulative preference shares Perpetual subordinated debt Perpetual subordinated securities Tier 3 All other capital instruments Global Association of Risk Professionals. All rights reserved.

7 More than actuarial number-crunching Pillar I Pillar 2 Pillar 3 (Numbers) (Governance) (Transparency) Eligible Capital Technical provisions Investment capital requirement Risk dependencies Risk measures & assumptions Calculation formula Internal model approach Own Risk & Solvency Assessment - ORSA Use Test Internal controls Risk management Risk appetite Risk mitigation Stress testing Continuity testing Regulatory reporting IFRS from 2016 Corporate risk appetite statement Demonstrating adequate resources Governance & Regulatory Supervision Public Disclosure & Regulatory Reporting Global Association of Risk Professionals. All rights reserved.

8 Own Risk & Solvency Assessment - ORSA At least once per year, the Board of Directors must deliver to the regulator a document of approximately 20 pages, describing: The governance of the models used to calculate capital requirements The governance of the scenarios, assumptions and parameters underpinning the capital model What role do the capital models play in setting strategic directrion The Board s assessment of capital required to deliver strategy The Board s assessment of corporate risk appetite Business continuity planning Internal audit Documentation of procedures What management information has the Board examined to ensure that key risks are identified and controlled How is risk management and awareness embedded into the company culture The Use Test Global Association of Risk Professionals. All rights reserved.

9 Dependencies within the DFA Model The Use Test and Risk Adjusted Capital In order to satisfy regulators that the Capital model is part of everyday business, many companies have been forced to push the concept further: Having calculated the total capital required for the business, the underwriting capital (usually ca 68-70% of the total) is broken down by Line of Business or by portfolio The amount of capital assigned may depend upon number of risks in the portfolio, or total premium income in the portfolio The target Return on Capital will depend upon Catastrophe events Common inflation factors Attritional losses Large loss frequencies Correlations between attritional losses and large/catastrophe events This capital assignment must flow into the pricing models used to underwrite business. The capital assignment must flow into underwriting limits NOTE THAT CAPITAL ASSIGNMENT OR UNDERLYING RETURN REQUIREMENTS CANNOT BE CHANGED OR IGNORED SIMPLY BECAUSE THE BUSINESS DOES NOT LIKE THE RESULTS! Global Association of Risk Professionals. All rights reserved. 9

10 More than actuarial number-crunching Pillar I Pillar 2 Pillar 3 (Numbers) (Governance) (Transparency) Eligible Capital Technical provisions Investment capital requirement Risk dependencies Risk measures & assumptions Calculation formula Internal model approach Own Risk & Solvency Assessment - ORSA Use Test Internal controls Risk management Risk appetite Risk mitigation Stress testing Continuity testing Regulatory reporting IFRS from 2016 Corporate risk appetite statement Demonstrating adequate resources Governance & Regulatory Supervision Public Disclosure & Regulatory Reporting Global Association of Risk Professionals. All rights reserved.

11 Disclosure At least once per year, the Company must deliver: A public report the SFCR Solvency & Financial Condition Report, covering Business and performance System of Governance Capital management A confidential report to the Regulator the RTR Return to Regulator, covering Business and performance System of Governance Capital management Risk profile Valuation for Solvency purposes Global Association of Risk Professionals. All rights reserved.

12 A handy list of acronyms Don t be put off by the jargon! SFCR Solvency & Financial Condition Report (public) RTR Return to Regulator (confidential) ORSA Own Risk & Solvency Assessment TP Technical Provisions (= reserves) MCR Minimum Capital Requirement SCR Solvency Capital Requirement Pillar 5 shorthand for Pillars 2&3 PAQC Pre-Application Qualifying Criteria Global Association of Risk Professionals. All rights reserved. 12

13 Questions? Global Association of Risk Professionals. All rights reserved.

14 C r e a t i n g a c u l t u r e o f r i s k a w a r e n e s s Global Association of Risk Professionals 111 Town Square Place 14th Floor Jersey City, New Jersey U.S.A nd Floor Bengal Wing 9A Devonshire Square London, EC2M 4YN U.K (0) About GARP The Global Association of Risk Professionals (GARP) is a not-for-profit global membership organization dedicated to preparing professionals and organizations to make better informed risk decisions. Membership represents over 150,000 risk management practitioners and researchers from banks, investment management firms, government agencies, academic institutions, and corporations from more than 195 countries and territories. GARP administers the Financial Risk Manager (FRM ) and the Energy Risk Professional (ERP ) Exams; certifications recognized by risk professionals worldwide. GARP also helps advance the role of risk management via comprehensive professional education and training for professionals of all levels Global Association of Risk Professionals. All rights reserved.