Workshop DACT. Leadership, Knowledge, Solutions Worldwide. Marsh Risk Consulting. February 15, 2011

Transcription

1 Workshop DACT Marsh Risk Consulting February 15, 2011 Leadership, Knowledge, Solutions Worldwide.

2 Agenda Welcome by Rob de Jonge Solvency II by Marc Paasch Credit Risk Management Optimization by Marc Paasch Coffee break Current status & trends insurance market by Joris van Eck Drinks Marsh Leadership, Knowledge, Solutions Worldwide. 1

3 Solvency II requirements Marc Paasch - Marsh Risk Consulting February 2011 Leadership, Knowledge, Solutions Worldwide.

4 Solvency II What is it? Pillar I SOLVENCY II Pillar II Pillar III SCR ERM Reports Pillar I: Quantitative Requirements The risk based capital calculation can be performed using either the standard prescribed formula or an internally designed model. The usage of any such internal model is subject to approval from the relevant supervisory body. Supervisors may request that an internal model is used to quantify the solvency capital requirement (SCR) if they feel that the standard calculation does not accurately reflect the risk profile. Own funds held (which are offset against the SCR) are to be assessed using a whole balance sheet approach. The principles are based upon the fair value concept which is prevalent within International Financial Reporting Standards. Pillar II: Qualitative Requirements If an internal model is used by an entity then the rationale and assumptions used in the model must be documented in detail. Each (re)insurance undertaking must document their systems of governance, risk management and capital structure. Group solvency rules will allow for some degree of intra-group support, subject to supervisor approval. (Re)insurance groups will have a group supervisor. The group supervisor will work closely with the supervisors of each of the subsidiary entities in order to set the group SCR. Pillar III: Disclosures Public disclosure requirements are to become far more rigorous as a stated aim of Solvency II being a move towards a more transparent regulatory regime. In particular, annual reports are required to be issued containing the key details with regards to the solvency of the undertaking. Marsh Leadership, Knowledge, Solutions Worldwide. 3

5 Solvency II Proportionality principle and treatment of captives Recital 19, Solvency II Directive The Directive should not be too burdensome for small and medium-sized insurance undertakings. One of the tools to achieve 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 Framework principles formally define a captive. This is in line with the Reinsurance Directive implemented in A captive should meet the following requirements: all insured persons and beneficiaries of the insurance obligations are legal entities of the group of the captive insurance or reinsurance undertaking. all insured persons and beneficiaries of the underlying direct insurance contract of the reinsurance obligations are legal entities of the group of the captive insurance or reinsurance undertaking. the insurance obligations of the direct insurance captive undertaking do not relate to any compulsory third party liability insurance. Scale Restrictive opt out for captive owners if premium income below EUR5 million per annum (and can fulfil other requirements concerning size of provisions and risk underwritten) Nature Complexity Proportionality Marsh Leadership, Knowledge, Solutions Worldwide. 4

6 Solvency II Key milestones Development of Directive (Commission) Negotiation & adoption of Directive Proposal (Council & Parliament) Implementation preparation (Member States) April 2009 July 2007 Directive Proposal Directive adopted Oct Jan.2010 CEIOPS advice for the implementing measures 2011 Adoption of implementing measures January 2013 Solvency II start date QIS 3 QIS 4 QIS 5 Marsh Leadership, Knowledge, Solutions Worldwide. 5

7 Solvency II Captive market activity A significant amount of lobbying continues with CEIOPS and EU Commission Risk management associations, European Captive Insurance and Reinsurance Owners Association (ECIROA), captive management associations and captive managers are largely speaking with a similar voice for change Campaigning on the following points: Joint ventures (restricted definition of a captive) and partnerships from excluded captive definition QIS6 (restricted) if QIS5 yields results that are extremely different from QIS4 Less conservative simplifications so as to make them more useful More specific Pillar II guidelines Simplified catastrophe modelling Marsh Leadership, Knowledge, Solutions Worldwide. 6

8 Solvency II Third country equivalence The Directive creates an equivalent country concept EU regulators can determine whether a third country has an insurance regulatory regime of equivalent standing to Solvency II If yes, then there are no consequences for an EU insurer or reinsurer doing business with an insurer or reinsurer in that third country If no, then the value of any reinsurance purchased by the EU company from the company in a nonequivalent country is discounted by at least 30% over and above the value determined by the Standard Model Equally, if an EU company is part of a larger group not in an EU equivalent country then the EU regulator will require information on the solvency and regulation of the parent of the EU company EU Commission will be able to compel EU companies to establish EU holding companies if owned by a company in a non-equivalent country Some third countries are therefore seeking equivalence such as Bermuda The Bermuda Monetary Authority has been consulting with Bermuda based companies on an equivalent regime Marsh Leadership, Knowledge, Solutions Worldwide. 7

9 Directive requirements Pillar 1: SCR & MCR calculation Pillar I SOLVENCY II Pillar II Pillar III The capital requirements under Solvency II: The Solvency Capital Required (SCR): the amount of capital held by a company ensuring its Board it can meet its liabilities over the next 12 months The Minimum Capital Required (MCR): the amount of capital below which the insurance license is withdrawn SCR ERM Reports Assets Market value NAV Market consistent value of the company Technical provisions Market value Free Surplus SCR MCR Coverage of a 99.5% probability of ruin, should cover the 1 in 200 years loss NAV (Assets Liabilities) > SCR (including MCR) The Directive provides three options for calculating the SCR: Standard Model the Directive states the required calculation of the capital. Partial Internal Model this incorporates the Standard Model but individual modules can be replaced with an internal approach that is agreed with the Regulator Full Internal Model this is a bespoke model developed by the company covering at least the same aspects as the Standard Model and which have been tailored to the specific characteristics of that company. Marsh Leadership, Knowledge, Solutions Worldwide. 8

10 Directive requirements Pillar 1: New risk taxonomy in QIS 5 Pillar I SOLVENCY II Pillar II Pillar III SCR ERM Reports Level 4 Level 3 Level 2: Aggregation of risks by typology Level 1: Evaluation of each risk module Bottom up approach with the aggregation of capital charges through correlation matrix Marsh Marsh Leadership, Knowledge, Solutions Worldwide. 9 9

11 Directive requirements Pillar 1: Lessons learnt & best practices Pillar I SOLVENCY II Pillar II Pillar III SCR ERM Reports When applying Solvency II requirements to captive, simplification factors need to be included for practical use We recommend specific monitoring and information regarding the Cat Risk exposures and liability durations Pure fronting captives will experience much higher level of SCR (Counterparty Risk effect) The Concentration risk needs a better calibration QIS 5 last recommendations : The Catastrophic risk calibration has been detailed within two methods : A method based on man-made and NatCat scenarios A factorial method to be applied, if the first one is not applicable The Counterparty risk now includes default risk of risk mitigation contracts, that is securitization and reinsurance, to address all counterparty issues encountered by captives Marsh Leadership, Knowledge, Solutions Worldwide. 10

12 Directive requirements Pillar 1: Current Solvency Ratio for Captives Pillar I SOLVENCY II Pillar II Pillar III SCR ERM Reports 35 % of captives (mainly small ones) wouldn t have enough capital to reach the SCR 35 % of captives have 180 % of SCR as available capital The first 10 % of captives have more than 400% of SCR 35% 30% Part of Captives 25% 20% 15% 10% Part of Small Captives Part of Medium Captives Part of Large Captives 5% 0% < 90% 90% - 100% 100% - 120% 120% - 150% 150% - 180% 180% - 250% 250% - 400% > 400% Solvency Ratio Marsh Leadership, Knowledge, Solutions Worldwide. 11

13 Directive requirements Pillar 1: Main risks encountered Pillar I SOLVENCY II Pillar II Pillar III SCR ERM Reports Non-life risk is the major risk in terms of impact on the level of SCR It is mainly to constitute of catastrophic risk Life & Health risk does concern only a few captives Part of captives Higher than 50% of the SCR Lower than 50% of the SCR Market Risk Default Risk Non Life Risk 2 Health Risk 1 Life Risk Marsh Leadership, Knowledge, Solutions Worldwide. 12

14 Directive requirements Pillar 2: Reference articles Pillar I SOLVENCY II Pillar II Pillar III SCR ERM Reports Outsourcing (art. 49) General governance (art. 41) Actuarial function (art. 48) Fit and proper requirements (art. 42) Internal audit (art. 47) Components Functions and activities Proof of good repute (art. 43) Internal control (art. 46) Own risk and solvency assessment (art. 45) Risk management (art. 44) Compliance to Pillar 2 is to be implemented according a proportionate approach based on best practices and ORSA high-level principles Marsh Leadership, Knowledge, Solutions Worldwide. 13

15 Directive requirements Pillar 2: Lessons learnt & best practices Pillar I SOLVENCY II Pillar II Pillar III SCR ERM Reports We recommend a proportionate approach for captives in line with the Level 1 Proportionality Principle defined in the Directive The ORSA remains at the core of Pillar 2 requirements The implementation of Solvency II Directive for captives shall follow clear steps: Defining a global approach Elaborating a clear compliance audit grid Setting a compliance target and high-priority action plans Defining and formalizing compliance elements Captive best practices guidelines are under review and shall assist companies in implementing Solvency II (see current best practices on next slide) Marsh Leadership, Knowledge, Solutions Worldwide. 14

16 Directive requirements Pillar 2: Captive best practices (1/2) Pillar I SOLVENCY II Pillar II Pillar III SCR ERM Reports Elements to be defined, documented and notified to the Supervisory Authority: Articles Article 41 Article 42 & 43 Article 44 Article 45 Captive best practices A transparent organisational structure with channels of communication and segregation of responsibilities including composition, responsibilities and duties of the Board of Directors. It shall be approved by the Board, revised annually and fully documented. Members may be senior employees of its Parent Company of Group. A list of key functions and minimal requirements of adequate professional qualifications, knowledge and experience. Key functions may be Board members and sub-committee experts reporting to the Board on specific areas. In addition captives shall provide the extract of the judicial record or equivalent for each key member. Suitable risk management strategy, policy, processes and reporting procedures covering all required risks including notably outsourced risk management functions and responsibilities. The captive shall establish guidelines for identifying, assessing and monitoring its risks. A document addressing all the strategic areas of the captive business backed up by a solid group of written policies dealing with other Directive requirements. Waiting the final text from EU in spring 2011 Marsh Leadership, Knowledge, Solutions Worldwide. 15

17 Directive requirements Pillar 2: Captive best practices (2/2) Pillar I SOLVENCY II Pillar II Pillar III SCR ERM Reports Elements to be defined, documented and notified to the Supervisory Authority: Articles Article 46 Article 47 Article 48 Article 49 Captive best practices (following) An efficient internal control system including a compliance manager, objectives and control procedures including compliance of outsourced functions An independent internal audit process within the scope of the group internal audit function or, where excluded, outsourced to an external company with appropriate and relevant experience The actuarial function coordinates the calculation and details the appropriateness of technical provisions and reinsurance arrangements it provides to the Board. Parts of the calculation process may be outsourced if necessary. Its tasks also includes express an opinion on the overall underwriting policy. Actuarial function members must be fit and proper. A written Outsourcing Policy including all outsourced and key in-sourced functions and/or activities and relevant justifications including proof of compliance to the captive s strategy. Captives shall have a written Service Level of Agreement in force with each Provider for critical functions. It shall be approved by the local regulator before being implemented. Marsh Leadership, Knowledge, Solutions Worldwide. 16

18 Directive requirements Pillar 3: Public disclosure Pillar I SOLVENCY II Pillar II Pillar III An annual solvency & financial report must be publicly disclosed and contained a description of : The business pursued and the performance of the undertakings The system of governance and assessment of its adequacy to the risk profile Each risk category and the risk exposure of the undertakings SCR ERM Reports Technical provisions and other liabilities, for each assets, including solvency valuations principles The capital management including the structure and amounts of own funds, the SCR and MCR, and their solvency valuation principles Required information may not be disclosed if it enables competitors to gain an undue advantage and/or if there are obligations to secrecy and confidentiality Marsh Leadership, Knowledge, Solutions Worldwide. 17

19 Contact : Marc Paasch, Head of Marsh Risk Consulting France marc.paasch@marsh.com Leadership, Knowledge, Solutions Worldwide.

20 Annex Pillar 2: Level 3 proposals Art. 41 to 43 Articles 41 General governance requirements Marsh main concern To be fully documented by a code of procedure : Approved by the board Revised annually Covering at minimum the art. 42 to 49 + Contingency plan Main goals = segregation of responsabilities & free flow of information Directive (FYI) 42 Fit and proper requirements for persons who effectively run the undertaking or have other key functions We shall formalise : 1- A list of key functions ("persons who run the undertaking") ex : Board of Directors, committee(s), risk management, compliance, internal audit, actuarial functions, Some minimal requirements of adequate professional qualifications, knowledge and experience 43 Proof of good repute The extract of the judicial record, a declaration on oath, a solemn declaration made by a competent authority of these Member States for all key members appears sufficient as a proof of good repute. Thus captives shall collect one of these elements for each acknowledged key employee. Further more, most of them are employed or approved by the captive shareholder. Marsh Leadership, Knowledge, Solutions Worldwide. 19

21 Annex Pillar 2: Level 3 proposals Art. 44 Articles Marsh main concern All the aspect of RM have to be covered by the code of procedure Directive (FYI) 44 Risk management (a) coordinate the calculation of technical provisions; (b) ensure the appropriateness of the methodologies and underlying models used as well as the assumptions made in the calculation of technical provisions; (c) assess the sufficiency and quality of the data used in the calculation of technical provisions; (d) compare best estimates against experience; (e) inform the administrative, management or supervisory body of the reliability and adequacy of the calculation of technical provisions; (f) oversee the calculation of technical provisions in the cases set out in Article 82; (g) express an opinion on the overall underwriting policy; (h) express an opinion on the adequacy of reinsurance arrangements; and (i) contribute to the effective implementation of the risk-management system referred to in Article 44, in particular with respect to the risk modelling underlying the calculation of the capital requirements set out in Chapter VI, Sections 4 and 5, and to the assessment referred to in Article 45. Tracking all the risks within all the processes (from identification to board report including quantify, monitoring & management) If a partial or full internal model : design, test, document, analyze and report on the internal model's performance Marsh Leadership, Knowledge, Solutions Worldwide. 20

22 Annex Pillar 2: Level 3 proposals Art. 45 to 50 Articles Marsh main concern Directive (FYI) 45 Own risk and solvency assessment (ORSA) 46 Internal control 47 Internal audit 48 Actuarial function 49 Outsourcing 50 Implementing measures Waiting the final text from EU in spring As per the best practices / procedures of the outsourcing ccopany or shareholder's rules including "administrative and accounting procedures, an internal control, reporting and compliance function." If the work is outsourced, the outsourcing company should be regulated and approved by the same local regulator as the (re)insurance company, or an equivalent body. This would automatically mean that all the services that the outsourcing company provided would be validated by the local regulator or an equivalent body. To be done by the shareholder's internal audit team or outsourced by them, the internal audit report shall be sent to the captive board who should follow the recommendations. We would recommend that the timing of the internal audit should follow the group's normal standards. Input of the technical provisions, underwriting policy, and reinsurance arrangements. (to be completed by Paris) The outsourcind company should be regulated and approved by the same local regulator as the (re)insurance company, or an equivalent body. This would automatically mean that all the services that the outsourcing company provided would be validated by the local regulator or an equivalent body and would ensure that all the items 49 (2) are complied with. Waiting the final text from EU. Art. 50 (1d): outsourcing companies in third countries should be accepted if they are regulated and approved by a local regulator, or an equivalent body in a European member state. Marsh Leadership, Knowledge, Solutions Worldwide. 21

23 Annex Pillar 2: Level 3 proposals ECIROA Items Current Text Comments Deloitte comment - 1. Framework of the document We would reshape the document to be more in line with the Solvency II framework. The current document mix various SII topics differently (e.g. Internal audit, Compliance, Outsourcing, etc. are described under risk management ). We would be more SII oriented : General comments - General governance requirements - Internal Control and Audit - Actuarial Function - Risk Management - Documentation and Reporting - ORSA2-2. Focus on key points For captive companies, we could point out some key issues that must indisputably be addressed such as Outsourcing, Reinsurance and Lack of diversification. We would emphasis specific sections about these topics with perhaps more detailed practices. Marsh comment: Agree to a re-shape of the document slightly so as to follow the Pillar 2 Articles. We should keep the document brief and to the point. More detailed policies daling with the Articles will be put in place for each captive but don't need to be spelled out here. 3- Diversity in captive undertakings nature and structure We should think about pointing out the various existing types of captive vehicles to emphasize their various risk profile and strengthen the idea that a single regulation would not be appropriate. For example, it could be useful to separate pure or single parent/group captives from other captive structures. If we are working on a lobbying issue, defining a (simple) scale of complexity for captive undertakings could help to enhance the message and could be achieved, for example, by mixing elements from the various type of captives described by IAIS and the criteria defined in CP79 to allow captive simplifications. Marsh Leadership, Knowledge, Solutions Worldwide. 22

24 Annex Pillar 2: Level 3 proposals ECIROA / Introduction Items Current Text Comments Introduction Captive Insurance Companies (Captives) are insurance or reinsurance undertakings. Their purpose is to provide insurance or reinsurance cover for the risks of the group to which they belong. They are run by a board of Directors (the Board) which makes all decisions regarding the captive. Captives are an important risk management tool for multi-national companies. They add flexibility to the tools available to the Risk Manager for financing and mitigating the risks of the Captive s Parent Company in a cost efficient manner. They are often used to provide alternative solutions for risks which may not be provided for in the external insurance market and in many cases, add an extra level of protection (e.g. by insuring deductibles). The characteristics of Captives are:- 1. They have a restricted number of insureds / clients, usually their Parent Company. 2. They write a restricted number of lines of insurance business (e.g. property damage & liability) and normally issue a small number of policies (e.g. one policy per insurance class) or sign a small number of reinsurance agreements. 3. They insure or reinsure a restricted number of risk units (e.g. sites, premises, vehicles) 4. They generally have a stronger ability than commercial insurers to influence the risk management practices of their insured entities. Captives are companies which often outsource up to 100% of their services to other professional companies. This outsourcing is done to ensure that a broader and more appropriate level of expertise is brought to bear on the company s activities, if needed. The risk appetite for the Captive is determined by the Board which has overall responsibility for the management of the underwriting risks and all consequential functions (such as reserving, investment management etc.). Due to the nature of Captives (as described above) the risk appetite and risk management procedures and techniques are transparent and can be easily documented and validated. The majority of Captive risks are easily explainable. Captives should consider the Proportionality Principle when establishing corporate governance frameworks and risk management policies which should reflect the nature, scale and complexity of the Captive. We should think about pointing out the various existing types of captive vehicles to emphasize their various risk profile and strengthen the idea that a single regulation would not be appropriate. For example, it could be useful to separate pure or single parent/group captives from other captive structures. Marsh Leadership, Knowledge, Solutions Worldwide. 23

25 Annex Pillar 2: Level 3 proposals ECIROA / RM System Items Current Text Comments related to RISK MANAGEMENT SYSTEM A captive is itself a risk management tool used by its owner. The captive is therefore part of the risk management function of its parent company. The captive is usually a very lean organisation comprised of its Board and outsourced functions. Therefore the risk management system for a captive is very straightforward. Captives should have a Risk Manager who reports to the Board and who can also be a member of the Captive Board. The different functions and responsibilities of the Board relative to the management of risks should be defined and documented. A process for self assessing the major captive risks should be put in place and the findings should be regularly reported to the Board and updated. Outsourced functions should be included in this process. Aon comment - This engagement should be formalised with an internal outsourcing agreement or appointment to a captive subcommittee. Whatever is put in place it needs to be transparent and clear. FERMA comment - We should not mention the ORSA report art 44 art 44 art 44 The Board should document its risk strategy and corresponding risk positions. This could be done by using an ORSA equivalent report. Outsourced functions should report their compliance with the captive s strategy to the Board. Deloitte comment: This will be a key factor as the Principle of Proportionality on this specific item will be crucial. Karel van Hulle has often said that the captive community was complaining but not really proposing... So, we should take him at his word and already think about concrete ORSA simplification proposals to submit (summary of a simpler framework of an ORSA report for captives and why, listing needed items with simpler principles for captives, etc.). Marsh comment: In dealings with local regulator during 2010 we understand that a conscise & clear ORSA document addressing all the strategic areas of the captive business should be sufficient to meet the requirments of the directive. This must be backed up by a solid group of written policies dealing with the requirements set out in the Directive FERMA comment - Do we need this comment? art 45 Marsh Leadership, Knowledge, Solutions Worldwide. 24

26 Annex Pillar 2: Level 3 proposals ECIROA / Governance 1 Items Current Text Comments related to GOVERNANCE The Captive Board of Directors (the Board) is responsible for the Captive s organization, administration and affairs and the general Art 41 governance requirements are fulfilled by the Board. Composition of the Board art 42 The Board should be comprised of members having sufficient and appropriate experience to provide sound and prudent management of the Captive who may be senior employees from its Parent Company or Group Marsh comment: captives will have no option but to follow the 'Fitness & Probity' requirments laid down by supervisory authorities. So this should be stated in this document. They may appear onerous to some buthave been in place in some jurisdictions for some time so not really a concern. art 42/43 Responsibilities of the Board Aon comment - the message from this section would be a lot stronger if more Solvency II language was used. The Board is responsible for:- Setting the strategic qualitative and quantitative goals of the Captive; Establishing and documenting all policies and procedures for corporate governance including the risk management policy and a art 41 formalized document that defines the design and operation of the Board itself; Checking, communicating and documenting guidelines and art 41 instructions on how the company should be run; Ensuring that there is satisfactory control of the Captive s financial art 44 accounts and management of assets; Ensuring that the Captive complies with all applicable laws and Art 46 regulations; The appointment of Service Providers art 49 Marsh Leadership, Knowledge, Solutions Worldwide. 25

27 Annex Pillar 2: Level 3 proposals ECIROA / Governance 2 Items Current Text Comments related to GOVERNANCE The Captive Board of Directors (the Board) is responsible for the Captive s organization, administration and affairs and the general Art 41 governance requirements are fulfilled by the Board. Duties of the Board art 41 The Board should:- art 41 meet on an appropriately frequent basis: art 41 make all decisions and have in place a formalised document that art 41 defines the criteria and procedures for decision making; perform the key functions of the Captive including the Risk art 41 Management function; establish such sub-committees (to include external experts if needed) to report to the board on specific areas which ultimately art 41 impact the stability of the Captive examine the ability and capacity of any outsourced provider to deliver services to the Captive. Ensure that the terms and conditions of any art 41 outsourcing agreement are understood and monitor any outsourcing arrangements; have a defined and documented communication plan. The plan should contain the type of information, deadlines and recipient. A art 41 communication system is not required. ensure that the Register of Assets is updated correctly and regularly art 41 ensure that insurance undertakings providing fronting services for the captive meet solvency requirements as defined in the Captive risk art 41 management policy. Marsh Leadership, Knowledge, Solutions Worldwide. 26

28 Annex Pillar 2: Level 3 proposals ECIROA / RM Policy 1 Current Text Comments related to Risk Management Policy art 44 art 44 The Captive should have a specified and documented risk management art 44 policy which includes the following:- 1) Underwriting and reserving art 44 The type of risks, underwriting procedures, self-retention amounts, reinsurance, reserving (including IBNR reserves) and instructions for art 44 claims handling. 2) Asset-liability management art 44 Including written instructions on how the Register of Assets is to be updated and how often. art 44 3) Investment management art 44 4) Liquidity management art 44 Procedures for ensuring that the captive maintains sufficient liquidity as needed to meet the financial requirements and maintains adequate assets to cover technical reserves. 5) Concentration risk management art 44 6) Operational risk management art 44 7) Reinsurance and other risk mitigation techniques art 44 8) Credit risk management art 44 9) Strategic risk art 44 The Captives Strategic Business Plan should be re-evaluated every 3-5 years or sooner if relevant issues arise. The Board should review the activities of the Captive in relation to the Business Plan on an annual basis. 10) Internal audit and control art 47 art 44 art 44 Marsh Leadership, Knowledge, Solutions Worldwide. 27

29 Annex Pillar 2: Level 3 proposals ECIROA / RM Policy 2 Current Text Comments related to Risk Management Policy art 44 A captive should fall within the scope of the parent company or group internal audit function. Where it is excluded on the basis of materiality, a captive will be expected to outsource its internal audit and control function to an external company which has appropriate and relevant experience. All internal audit or review functions should have a complete and unrestricted right to obtain information from all sources. Aon Comment: It is probably worth drawing the distinction between internal audit and internal control. The level 2 implementing measure states the The internal audit function should evaluate the adequacy and effectiveness of the internal control system. Is it possible to include an explanation of how this will be addressed in the captive model? At the limit reference should be made to the Company/ Boards control and direction on this in line with their outsourcing responsibilities e. g. The Captive may engage an outsourced service provider to carry out the internal audit in line with the Company's written internal audit Policy setting out the responsibilities, goals, processes and reporting procedures to be applied in line with the Company's overall business strategy'. Again. the Internal Control function will be in line with the Company's written internal Control Policy setting out the responsibilities, goals, processes etc. Also note should be made that s the internal control system itself will be monitored on a continuous basis in line with the outsourcing policy. Marsh comment: We feel that the internal audit and review function should be treated in proportion to the size and type of captive operation. In some cases it may be done internally and in other cases it will be done by external providers. But in all cases it will be the captive board with the captive parent company who should decide. The results should be submitted to the captive board to ensure appropriate clarifications and follow up. art 47 art 47 Marsh Leadership, Knowledge, Solutions Worldwide. 28

30 Annex Pillar 2: Level 3 proposals ECIROA / Compliance Current Text Comments related to 11) Compliance Aon comment: As Compliance relates to Internal Control (refer to article 46) and should probably be included under this heading. The level 2 implementing measure states that 'The internal audit function should evaluate the adequacy and effectiveness of the internal control system'. Can we include how this will be addressed within the captive model. art 46 The Captive Board is responsible for compliance. The Captive Board should use all reasonable endeavours to be at all times in compliance with applicable legislation in accordance with good corporate governance and codes of The compliance report to the Board should art 46 List of identified compliance terms of art 46 List of controls to address these art 46 Compliance monitoring: specifying area tested, work done & findings art 46 art 46 art 46 Marsh Leadership, Knowledge, Solutions Worldwide. 29

31 Annex Pillar 2: Level 3 proposals ECIROA / Outsourcing 1 Items Current Text Comments related to 12) Outsourcing art 49 Marsh Comment: A formal written outsourcing policy should be put in place. Due to the nature of the captive model this policy will be fairly standard in nature and does not need to be a lengthy document. Once it Due to the absence of its own employees, the captive may refers to the key functions being outsourced and clearly states the outsource all or a substantial part of its key functions. conditions for entering into outsourcing arrangements, notifications to art 49 The Board is however responsible for all outsourced the supervisory authorities, written agreements with the service business. providers with service level agreements and most importantly monitoring/ approval of the appointment process and performance review process. Some captives choose to in-source certain functions and will employ parent company or Group company staff to carry out these functions (e.g. where certain expertise is needed or where it is more cost efficient). Aon comment: The reference to 'In-sourcing' might be unnecessary as it is has a few meanings. 'will employ parent company staff' is sufficiently adequate and clear. Marsh comment: Agree but in some cases where extensive services are provided by captive parent company employees a formal agreement may be needed to clearly identify roles & responsibilities. e.g. in the area of claims handling or treasury/ investment services to ensure the captive board have control over these. The outsourced services may include:- art 49 Actuarial services art 49 Banking Marsh comment: mention of Investment Management should suffice as banks are external to captive in most cases. art 49 Internal Audit art 49 Captive administration services art 49 Claims management art 49 Insurance broking Marsh comment: include reinsurance/ retrocession placing art 49 Investment management art 49 Legal services art 49 Compliance support art 49 Risk management support art 49 art 49 The outsourcing may be to professional external companies or may also be to a function within the Parent Company. art 49 Marsh Leadership, Knowledge, Solutions Worldwide. 30

32 Annex Pillar 2: Level 3 proposals ECIROA / Outsourcing 2 Current Text Comments related to 12) Outsourcing art 49 In all cases, the Captive should have a written Outsourcing Policy which describes the decision process behind the outsourcing of the various functions, how the Provider has been selected and how they are monitored. The Board is responsible for the selection and monitoring of Service Providers. FERMA comment - is a formal written policy necessary? Marsh Comment: Yes we believe it is necessary to have a formal policy in place. art 49 Captives should have a written Service Level agreement in force with each Provider which documents the services to be provided. This agreement must clearly state:- the respective rights and obligations of the captive and the Service Provider. art 49 The duties and responsibilities of both parties art 49 The ability of the Service Provider to comply with all laws and regulatory guidelines art 49 The basis of remuneration for services provided art 49 What the cancellation provision are for either party and must allow a sufficient time for the Captive to find an art 49 alternative solution. The Service Provider must demonstrate that:- Marsh comment: insert 'before selection' after the word demonstrate. art 49 art 49 Marsh Leadership, Knowledge, Solutions Worldwide. 31

33 Annex Pillar 2: Level 3 proposals ECIROA / Outsourcing 3 Current Text Comments related to 12) Outsourcing art 49 it has an adequate risk management and internal control system in place art 49 it is able to deliver the required functions satisfactorily art 49 the same provisions apply as to the Captive regarding safety and confidentiality of captive information art 49 it is able to respond to any questions addressed directly by the supervising authority art 49 the staff chosen by the Service Provider are of the required competence and experience. art 49 Aon comment: Reference should be made to the Company's own it has adequate contingency plans in place. contingency planning regarding business disruption from a failure of an outsourced service provider. Marsh comment: reference to art 49 Disaster Recovery and Business Continuity Plans will help. The Board is fully responsible for the monitoring and regular assessment of the outsourced functions. Key FERMA comment - should fronting be included? Performance Indicators should be a part of this assessment art 49 process. Marsh Leadership, Knowledge, Solutions Worldwide. 32

34 Annex Pillar 2: Level 3 proposals ECIROA / Cont. plans & conclusion Items Current Text Comments related to CONTINGENCY PLANS CONCLUSION Contingency plans to ensure that business disruption and/or possible losses are limited if there is an unforeseen interruption to systems and procedures should be documented, tested and monitored. The plans should be appropriate to the size of the captive and its structure. Captives may be included in the contingency planning of the parent company provided there is specific planning for the captive. Captives following this policy of documenting and validating their activities in detail should also have the option to explain (based upon these qualitative factors) the differences between the standard formula and eligible internal or partial internal model. Marsh comment: Since the captive outsources most of its management/ administration functions then it is likely that the parent company/ captive board will look to the service providers' business continuity plans to satisfy itself that they meet the specific requirements of the captive. In most cases the captive entity will be a completly different type of operation to the parent company business so will likely have different needs to the parent when faced with an unforseen interruption to business. Aon comment: It is worth spending some time expanding on this point as it is not very clear what it is getting at. Marsh comment: With QIS 5 and CP 79 completed we believe the quantitative requirements and the question of proportionality have been dealt with. We are not sure what is meant by this statement. art 41 Marsh Leadership, Knowledge, Solutions Worldwide. 33

35 Credit risk management optimization Marc PAASCH Marsh Risk Consulting Leadership, Knowledge, Solutions Worldwide.

36 Credit risk management optimization Introduction Non traditional solutions vs. the risk components Improving credit management practices Captives Alternative Risk Transfer Solutions Conclusion Marsh Leadership, Knowledge, Solutions Worldwide. 35

37 Solutions to manage debtors risks Industry Knowhow and Benchmark Political Risks Credit Insurance TOP-Up and XL-Policy IT Factoring Risk- Information Capital-Market Client Management Process Captive /ART Current Trade Credit Challenges The objective of our solution is to review the receivables hedging strategy and seek robust alternatives to support the businesses Marsh Leadership, Knowledge, Solutions Worldwide. 36

38 Risk Management Practices Understanding risk Before analysing in detail customer risk management process throughout the whole customer cycle of the organisation, we proceed to a global risk analysis Risk segmentation Risk quantification Risk tolerance Define an appropriate and ad-hoc customer typology according internal key indicators (impact on the company, risk frequency, existing risk cover, etc.) Formalise and implement risk quantification and monitoring method based on internal needs and external best practices Involve all departments in this process Define decision-making support indicators (e.g. credit limits) depending on the type of customer Develop associated quantification methods of such indicators Marsh Leadership, Knowledge, Solutions Worldwide. 37

39 Risk Management Practices Improving mitigation measures: Overview of the Customer Cycle Customer Cycle and Customer risk management Litigation Negotiation of financial terms Lettering collection Organisation Client Account Opening Outdoors Partners IT & Data Bases Strategy & business issues Process Guarantee decision Recovery People Order taking Litigation & Assets Billing Marsh Leadership, Knowledge, Solutions Worldwide. 38

40 Risk Management Practices Improving mitigation measures: step-by-step approach 1/2 The customer cycle is reviewed focusing on credit management measures throughout its processes to identify current vulnerabilities and improvement opportunities ETAPE STEP Negotiation Négociation of des financial conditions terms financières Ouverture Client opening de compte accounts clients Décision Guarantee de Decision garantie Prise Order commande taking Facturation Billing ANALYSE ACTIONS des ANALYSIS ACTIONS Time Délais of payment de paiement used utilisés Payment Outils de tools paiement used proposés Escomptes Discount Cautions et garanties existantes Existing bonds and guarantees Prospect Identification identification du prospect Securisation Sécurisation of account de l ouverture opening de compte Integrity Intégrité of the de database la client de données clients Informations and sources et sources used utilisées Risk Analyse analysis de risque Détermination de la limite de crédit (méthodes Determining the credit limit (methods of calculation, de calcul, autorisations, hiérarchie, comités de authorization, hierarchy, credit committee) crédit) Support Documents documents supports Links Lien / commande control / current / encours / credit limits / limite de crédit blocked Blocages accounts de compte Timing Cadencement of billings des facturations Terms Conditions of Sales Générales de vente Subject Réserve Property de propriété Marsh Leadership, Knowledge, Solutions Worldwide. 39

41 Risk Management Practices Improving mitigation measures: step-by-step approach 2/2 Litigation Litiges et and Avoirs assets Recouvrement Recovery Partenaires Outdoors Partners extérieurs Encaissement Lettering Collection / Lettrage Litigation Contentieux ETAPE STEP ANALYSE ACTIONS des ANALYSIS ACTIONS Identification and resolution et résolution of disputes des litiges Resolution Schémas schemes de résolution Personnes impliquées Persons involved Level Niveaux of reminders relances and pre-litigation amiables et timing précontentieuses and prioritization Cadencement et priorisation Credit insurance, business information company, software / platform Assureurs Recovery crédit, société de renseignement commercial, logiciels / plateformes de relance Flow regulations Accounts Flux de organisation règlement (moyens) Identification Organisation booking de errors la comptabilité Identification des erreurs d imputation Timing Délais Internalization Internalisation / Subcontracting / Sous traitance (agency, (agences, credit insurer, lawyers) assureurs crédit, avocats, etc.) Provisioning Provisionnement Marsh Leadership, Knowledge, Solutions Worldwide. 40

42 Risk Management Practices Improving mitigation measures: order taking example Order taking Current actions Compulsory order documents types Links and control between outstanding / credit limit Links and control between Locked / On hold accounts : when / why Improvement opportunities Observation: Revisions of credit limits are not automatic. Credit limits have to be adapted to the customers' amounts, which generates accounts locking and important work. Only the CFO can unlock the order. Recommendation: Locking of accounts based on late payments instead of credit limits amount might be an improvement. Marsh Leadership, Knowledge, Solutions Worldwide. 41

43 Risk Management Practices Improving mitigation measures: litigation example Litigation Current actions Timing follow-up Provisioning according a generalised Group process Centralised Internalisation Vs. Subcontracting (agencies, insurers/ brokers, lawyers, etc.) Improvement opportunities Maintaining litigation management actor in local Credit department to facilitate relations Implementing a Group-wide electronic documentation management tool dedicated to litigation Marsh Leadership, Knowledge, Solutions Worldwide. 42

44 Strategic Approach of Trade Credit Risks Enlarging the approach: Solutions vs. Risk Components Risk Components Default of Client Probability of Default of the hedge Uncertainty about the global economy and the overall probability of default Solutions Client Management 1: Guarantees (Conditional Sale, Deposit) 2a: Discounts / Bonus system 2b: Selection programs (Payment target, Prepayment, Deposit, etc.) Risk Transfer Solutions Alternative Risk Financing 3: Credit Insurance (XL Police, Top-Up, etc) 4a: Selective CDS Covers 4b: Capital Market Solutions i) Credit Default Swap (CDS) ii) MSCI-World Put iii) Country Spread Hedges 5: Captive / ART Equity Solutions 6: Equity, Risks on BS Marsh Leadership, Knowledge, Solutions Worldwide. 43

45 Risk transfer solutions Evolution of cover granted under traditional Credit Insurance (2007 / 2008) Fully Underwritten buyers 2008 Partially Underwritten buyers Declined buyers Risk appetite can fluctuate due to revised risk underwriting strategy! Marsh Leadership, Knowledge, Solutions Worldwide. 44

46 Complementary captive cover Evolution of cover granted under and solutions with top-up cover of captive Captive XL Cover Fully Underwritten buyers Partially Underwritten buyers 2008 Captive Cover 2007 Declined buyers Credit Checks Partial decisions supported by Captive lead to increased cover Marsh Leadership, Knowledge, Solutions Worldwide. 45

47 How is a Captive involved? General scheme There are 2 methods of writing trade credit business through a captive. The first involves a fronting insurer issuing a trade credit insurance policy to the original insured. A proportion of the risk is then reinsured to the captive. Insured Fronting Insurer Captive Reinsurers The second method involves the captive issuing policies directly to the original insured. Insured Captive Reinsurers Marsh Leadership, Knowledge, Solutions Worldwide. 46

48 How is a Captive involved? Captive implementation options Primary layer Quota share $100m $100m Policy limit Transferred to market: Excess layer(s) Policy limit Insured by market: 90% Retained: Quota share (10%) $10m $0 Retained: Primary layer $0 0% 100% Risk 0% 90% 100% Risk Marsh Leadership, Knowledge, Solutions Worldwide. 47

49 Why utilise a captive structure for trade credit insurance? Multiple benefits Total Cost of Risk Optimisation: optimal balance of retained and transferred risk Collection of group wide trade credit loss data and enhancing the risk management Ability to establish reserves, calculated on a verifiable basis, for Incurred But Not Reported ( IBNR ) losses and achieve tax benefits Access reinsurance and Alternative Risk Transfer markets Reduced sensitivity to market volatility as the captive is involved in directly pricing the risk Creating insurance capacity Marsh Leadership, Knowledge, Solutions Worldwide. 48

50 Why utilise a captive structure for trade credit insurance? Risk financing optimisation This diagram illustrates the concept of risk financing optimisation by reflecting the balance between certain costs e.g. premiums and uncertain costs e.g. retained claims and when appropriately modelled, an optimal solution can be established Total Cost of Risk 800, , , , , , , ,000 - Gross 10k / unlimited 25k / unlimited 50k / unlimited 100k / unlimited 200k / unlimited 300k / unlimited Retention / Aggregate Expected Retained Cost Transfer Premium Taxes, Expenses COR at 90% COR at Peak over 90% Marsh Leadership, Knowledge, Solutions Worldwide. 49

51 What are the potential disadvantages of using a captive for trade credit insurance? Potential to incur an underwriting loss that might otherwise have been transferred to the insurance market Cost of capital and operation From a captive perspective, it may also be possible for the captive to purchase a proportion of the receivables held by the group. Such a purchase simply becomes another type of investment for the captive. non-payment becomes the risk of the captive whilst helping to reduce direct insurance premium costs such a purchase can have the same effect of returning the cash to the business to be used in its core activities Marsh Leadership, Knowledge, Solutions Worldwide. 50

52 Captive Global Solution Example Credit XS-Cover Property With high SIR XS Aggregate Stop Loss or Multi-Year Multi-Line Captive Credit Property Liability Warranty Program SIR Fronting Marsh Leadership, Knowledge, Solutions Worldwide. 51

53 Alternative Risk Transfer Solutions Global overview 100 M Losses Program Structure ART Solutions 60 M 20 M Expected loss Captive Drop Structured Re-Insurance and CDS CDS Sovereign XS Credit Insurance SIR per activity Fronting Revenues Marsh Leadership, Knowledge, Solutions Worldwide. 52

54 Focus on structured (Re)-Insurance Excess Layer Risk Transfer (140m xs 10m) Structured Reinsurance SIR (1m) Year Marsh Leadership, Knowledge, Solutions Worldwide. 53

55 Conclusion Modelling and decision criteria: Group Risk Tolerance Total Cost of Risk optimisation (including concentration, correlation risks) Margin vs. Probability of Default Stability and robustness of the receivable solution Added value of a solution for uninsurable risks Solvency II Marsh Leadership, Knowledge, Solutions Worldwide. 54

56 Insurance market presentation February 15, 2011 Joris G. van Eck Senior Vice President / Global Account Division Leadership, Knowledge, Solutions Worldwide.

57 Agenda Introduction Renewal rates Economic factors that have brought the current softening markets Forces that could serve as catalysts for an eventual change Marsh Leadership, Knowledge, Solutions Worldwide. 56

58 Introduction The decline in rates on line at January 1, 2011 takes place following a year that began with significant catastrophe activity. Losses in the first half of the year were well above average and included Windstorm Xynthia (US$ 2bn US$ 4bn), the Deepwater Horizon oil rig loss and the Chile earthquake (US$ 6bn US$ 10bn). However, despite the New Zealand earthquake in the second half, the year finished with relatively low insured catastrophe losses - owing in large part to an unexpectedly low-loss hurricane season. Subdued losses, combined with unrealized investment gains, led to record levels of capital, which in turn drove reinsurance pricing lower at the renewal. Structures have not changed significantly: Cedents are buying similar amounts of cover to last year, with purchasing appetite helped by attractive pricing. Marsh Leadership, Knowledge, Solutions Worldwide. 57

59 Renewal rates (1) Marsh Leadership, Knowledge, Solutions Worldwide. 58

60 Renewal rates (2) Marsh Leadership, Knowledge, Solutions Worldwide. 59

61 Renewal rates (3) Marsh Leadership, Knowledge, Solutions Worldwide. 60

62 Renewal rates (4) Marsh Leadership, Knowledge, Solutions Worldwide. 61

63 Renewal rates (5) Low Yield High levels of sector capital Lower Rates On Line Combination caused Persistent low valuation of reinsurance companies Suppressed forward earnings rates Marsh Leadership, Knowledge, Solutions Worldwide. 62

64 Economic factors that have brought the current softening markets Most important drivers of capital development have been strong net income & unrealised investment gains Composite shareholders funds have grown 35% from US$ 85.2 bn to US$ 114.7bn. This has been despite large shareholders buybacks & dividends totalling US$ 12 bn and heavy first half 2010 u/w losses Most important pricing driver is simply the large amount of global r/i capital 11% (US$ 19bn) in excess of historical levels. When capital levels are above trend, r/i rates come under pressure Rates tend to rise during low capital years Marsh Leadership, Knowledge, Solutions Worldwide. 63

65 Change in equity; growing shareholders fund s Marsh Leadership, Knowledge, Solutions Worldwide. 64

66 Shareholders Funds Marsh Leadership, Knowledge, Solutions Worldwide. 65

67 Outlook 2011: Forces that could serve as catalysts for an eventual change Critical-Mass Loss Event A US$ 50 billion Individual Loss would be enough to stem the decline of rates A US$ 100 billion Individual Loss, Marsh believes outlier Reinsurance entity failures could take place A US$ 150 billion Individual Loss would certainly creates a sustained & long-term market turn Sustainability of reserve releases Sector under-reserving served as the backdrop for the last hard market Negative U/W cashflow Neg u/w cashflow is closely correlated with pricing cycles Prior to the last hard market, u/w cashflow turned negative u/w cashflow has turned at least marginally negative in 08 & 09 Marsh Leadership, Knowledge, Solutions Worldwide. 66

68 Global Reinsurance Cy s decline of Return on revenue Marsh Leadership, Knowledge, Solutions Worldwide. 67

69 Outlook 2011: Forces that could serve as catalysts for an eventual change Cont d Low valuations / increased M&A activity Means at valuation levels of 0.9x book value higher M&A activity in the past Combined with significant share buybacks already taking place in the sector New additional M&A activity could slow the growth of dedicated R/I sector capital Restricting the supply of R/I In turn could eventually drive rates higher Marsh Leadership, Knowledge, Solutions Worldwide. 68

70 P&C Insurance M&A activity Marsh Leadership, Knowledge, Solutions Worldwide. 69

71 Global Property ROL index Marsh Leadership, Knowledge, Solutions Worldwide. 70

72 Marsh Leadership, Knowledge, Solutions Worldwide. 71