The internal and external reporting

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1 The internal and external reporting Alberto Floreani School of Banking, Finance and Insurance Università Cattolica del Sacro Cuore, Milan 1

2 (C) Alberto Floreani - 26/11/ The reporting framework in Solvency II Reporting to the regulatory authority Market disclosure Internal reporting

3 Supervisory Reporting

4 (C) Alberto Floreani - 26/11/ Requirements for Supervisory Reporting No changes in the principles («Member States shall ensure that supervisory authorities have the power to require all information necessary to conduct supervision in accordance with Article 35» (art SII directive) but pan-european convergence of supervisory reporting («The Commission shall adopt implementing measures specifying the information referred to in paragraphs 1 to 4, with a view to ensuring to the appropriate extent convergence of supervisory reporting» art SII directive) and an increase of the content of regular supervisory reporting

5 (C) Alberto Floreani - 26/11/ Regular supervisory reporting Regular supervisory report (RSR) SINGLE ENTITY REPORTING at least every 3 years, no later than 14 weeks after the undertaking s financial year in question ends (20, 18, 16 weeks for 2016/17/18 financial years). Material changes in the RSR information should be submitted annually. Own risk and Solvency Assessment Report (ORSA report) Annually, within 2 weeks after concluding the assessment Quantitative Report Template (QRT) Annually (14 weeks, 20,18,16 weeks for 2016/17/18) Quarterly (5 weeks, 8, 7, 6 weeks for 2016/17/18) GROUP REPORTING Group RSR, ORSA report and QRT (6 weeks extension, except for ORSA Report)

6 (C) Alberto Floreani - 26/11/ Data quality The required time to produce QRTs is challenging Look through approach for investments Additional supervisory reporting required by national supervisory authorities? But Regular supervisory reporting: some issues - Supervisory reporting is just a technical and compliance matter

7 Market Disclosure

8 (C) Alberto Floreani - 26/11/ Solvency and Financial Condition Report Annually (14 weeks, 20, 18, 16 weeks for 2016/17/18, 6 weeks extension for group) Document longer than 100 pages Rigid and highly comparable structure Solo (single entity) and Group SFCR Required information should include System of Governance, Risks, Assets, Technical Provisions, Own Funds, internal model (if any) and «the amount of any non-compliance with the Minimum Capital Requirement or any significant non-compliance with the Solvency Capital Requirement during the reporting period, even if subsequently resolved, with an explanation of its origin and consequences as well as any remedial measures taken» (ART SII directive). Public QRT Required information should include Economic Balance Sheet, SCR and its macrocomponents, and own funds quality (tiering). Two key information items: Solvency Ratio (Total Eligible Own Funds to meet the SCR/ SCR Total Basic Own Funds (BOF) Market disclosure

9 (C) Alberto Floreani - 26/11/ Market disclosure: market discipline or window dressing? In the regulator view, market disclosure induces market discipline (i.e. a more prudent management approach in order to raise the Solvency Ratio) BUT It could also induce window dressing (i.e. derisking strategy just before financial year end). Supervisory authorities should prevent this practice, which could also affect financial markets.

10 (C) Alberto Floreani - 26/11/ Market disclosure: Effects The SCR is a (quite) precise measure of the insurance company risks (also in standard formula approach); BoF is measured using a full fair value approach and is a (quite) precise measure of the intrinsic value of the insurance company, i.e. embedded value; The quantitative measures are highly comparable across companies, also internationally The Solvency Ratio and the BoF disclosure could affect market value of listed insurance companies The Solvency Ratio disclosure could also affect commercial position of listed and unlisted insurance companies, especially for: Long term contracts (i.e. life insurance); Market segments where the distribution channel could select the insurance company partner (such as banking distribution with independent insurance company) Corporate Insurance where insurance partner is selected also by Solvency Ratio Market segments where the competition and the customer mobility is higher (i.e. Auto insurance)

11 (C) Alberto Floreani - 26/11/ Market disclosure: Effects Market disclosure is not only a technical and compliance matter. The potential impacts of market disclosure should be identified, assessed and, if that is the case, mitigated (in advance!!!).

12 (C) Alberto Floreani - 26/11/ Solvency II market disclosure and financial reporting In Italy there are three financial reporting metrics for insurance company value measurement: Solo reporting (local GAAP) Group reporting (IAS/IFRS) Solvency reporting at Solo and Group Level (Fair value) IFRS are changing (from IAS 39 to IFRS 9 for financial instruments with «deferral approach» or «overlay approach» transitional measures for insurance companies; from local Gaap to the IFRS phase 2 for technical provisions) More than one metrics could generate confusion in financial reporting users and avoidable administrative costs. In addition, the management has to control the accounting impact of operations in the three different metrics. Some simplifications are necessary

13 Internal Reporting

14 (C) Alberto Floreani - 26/11/ Internal reporting Internal reporting is a required part of the Solvency II Governance System. «Insurance and reinsurance undertakings shall [ ]: - establish, implement and maintain effective cooperation, internal reporting and communication of information at all relevant levels of the undertaking; [ ] - establish information systems which produce complete, reliable, clear, consistent, timely and relevant information concerning the business activities, the commitments assumed and the risks to which the undertaking is exposed; [ ] - introduce clear reporting lines that ensure the prompt transfer of information to all persons who need it in a way that enables them to recognise its importance as regards their respective responsibilities;» (art. 258 Delegated Regulation 35/2015)

15 (C) Alberto Floreani - 26/11/ Internal reporting internal reporting is required to monitor, on a continuous basis, the compliance with the capital requirements. «the own risk and solvency assessment shall include «the compliance, on a continuous basis, with the capital requirements and with the requirements regarding technical provisions» (art SII directive). «Insurance and reinsurance undertakings shall immediately inform the supervisory authority as soon as they observe that the Solvency Capital Requirement is no longer complied with, or where there is a risk of non-compliance in the following three months» (art. 138 SII directive).

16 (C) Alberto Floreani - 26/11/ Internal reporting internal reporting is required to evaluate the overall solvency needs on a forward-looking perspective. The assessment of an insurance overall solvency needs shall be forward-looking, i.e. «taking into account potential future changes in its risk profile due to the undertaking's business strategy or the economic and financial environment«(art. 262 Delegated Regulation 35/2015)

17 (C) Alberto Floreani - 26/11/ Internal reporting internal reporting is required especially for insurance companies which adopt an internal model. An internal model shall [ ] supports the relevant decision-making processes in the undertaking, including the setting of the business strategy; the internal model and its results are regularly discussed and reviewed in the administrative, management or supervisory body of the insurance or reinsurance undertaking; the outputs of the internal model, including the measurement of diversification effects, are taken into account in formulating risk strategies, including the development of risk tolerance limits and risk mitigation strategies; the relevant outputs of the internal model are covered by the internal reporting procedures of the risk management system. (art. 226 Delegated Regulation 35/2015)

18 (C) Alberto Floreani - 26/11/ Internal reporting Solvency II requires an adequate internal reporting system BUT The SII prescriptions are an opportunity to construct a comprehensive and structured system of internal reporting regarding risks, value and performance, not only as a part of the risk management and internal control system of the company, but also as a decision making support system (even in case of standard formula) This is the way to create value from the cost of implementing and maintaining the Solvency II framework.

19 (C) Alberto Floreani - 26/11/ Internal reporting Some examples: Compute SCR, BoF and Solvency Ratio on a continuous basis (i.e. monthly); SCR and BoF attribution at LOB or portfolio level; Strategic evaluation of business and risk mitigation operations in a Value (i.e. DBoF), Risk (i.e. DSCR) and Performance (i.e. Profit) framework. The design of the Solvency II internal reporting system is challenging. A technical, but very important aspect is the SCR attribution which suitably consider the diversification effects.

20 (C) Alberto Floreani - 26/11/ A simple example: what-if analysis An increase in longevity risk (i.e. more Personal Pension Products) is a good option for a typical Italian life insurance companies? Instinctive response: No, longevity risk absorb too much capital!!!

(C) Alberto Floreani - 26/11/2015 21 STARTING FROM A LOW LEVEL OF LONGEVITY RISK (10) Basic SCR 668 Market 500 Default 50 LIFE

50 = 60) Basic SCR 676,2 DSCR 8,2 Market 500 Default 50 LIFE 297,7 Health 50 Non-Life 0 Mortality 100 Longevity 60 Disability 10

21 (C) Alberto Floreani - 26/11/ STARTING FROM A LOW LEVEL OF LONGEVITY RISK (10) Basic SCR 668 Market 500 Default 50 LIFE 285,2 Health 50 Non-Life 0 Mortality 100 Longevity 10 Disability 10 Expense 50 Lapse 200 Cat 60 INCREASING LONGEVITY RISK ( = 60) Basic SCR 676,2 DSCR 8,2 Market 500 Default 50 LIFE 297,7 Health 50 Non-Life 0 Mortality 100 Longevity 60 Disability 10 Expense 50 Lapse 200 Cat 60 THE NET INCREASE IN SCR IS 8,2 (83,7% OF THE NEW LONGEVITY RISK IS ELIMINATED BY THE DIVERSIFICATION EFFECT)

22 (C) Alberto Floreani - 26/11/ A simple example: what-if analysis An increase in longevity risk (i.e. more Personal Pension Products) is a good option for a typical Italian life insurance companies? Internal reporting response : maybe yes, starting from a low level of longevity risk, an increase in longevity can be mostly diversified away!!! Remark: This example is purely illustrative, the effects of personal pension products on other risks (i.e. market risks and other underwriting life risks) are not considered.

23 (C) Alberto Floreani - 26/11/ Conclusion - Supervisory reporting is demanding but it is just a technical and compliance matter. - Market disclosure is not only a technical and compliance matter. The potential impacts of market disclosure should be identified, assessed and, if that is the case, mitigated. - Internal reporting is strategic issue. It should serve to support the decision making process and it is the way to create value from the cost of implementing and maintaining the Solvency II framework.

24 Thanks for your attention

The Solvency II project and the work of CEIOPS

Thomas Steffen CEIOPS Chairman Budapest, 16 May 07 The Solvency II project and the work of CEIOPS Outline Reasons for a change in the insurance EU regulatory framework The Solvency II project Drivers Process