International Regulatory Developments

Transcription

1 International Regulatory Developments An Introduction to Solvency II Simone Brathwaite, FSA, FCIA, CERA Principal Oliver Wyman December 2, 2010

2 Many bodies driving global regulatory change A simplification of the key interactions Leading standard setting bodies Cross-sector issues/ Regulatory Arbitrage Basel II & III Leading National regulators: eg Financial Stability Board Global Financial crisis/ Systemic risk solutions EU Solvency II model UK Swiss Australia Canada IAA Solutions to implications of IFRS4 IAIS Most influential benchmark for national regulators SII Equivalence United States 190 IAIS member jurisdictions/regulators Bermuda, Barbados, Jamaica, Trinidad, Brazil, Mexico, Japan, Korea, India, Singapore, NAIC, 56 US jurisdictions We will be highlighting the regulatory developments out of Canada and Solvency II 2

3 Solvency II is unquestionably the most significant regulatory change for the insurance industry that is happening right now Motivation the change was long overdue Solvency I was inept with dealing with the inherent risks of the modern insurance industry Some EU regulators (e.g FSA, FTK) were forced to revamp their frameworks before Solvency II Process was slow, but to be expected The leading EU regulators were able to guide the development of SII over the last 6 years But still needed to consider the realities of the implications on the various member countries and their industries Proposed outcome- not perfect but still pretty advanced leaped-frogged many existing frameworks Implementation date January 2013 All EU companies were advised to participate in QIS 5 for a final chance to help establish the final calibration of the solvency test Impacts the global industry Will impact IAIS s new initiatives Impacts countries with companies who do significant transactions with EU companies, including - International reinsurers in non-eu countries (third countries) Bermuda, Barbados - EU Group companies with subsidiaries outside of EU (AXA, ING, Global reinsurers) - Non-EU Group companies with subsidiaries operating in Europe (e.g RGA) 3

4 Solvency II 3 pillars SOLVENCY II Pillar 1 Quantitative requirements Market-consistent value of assets and liabilities SCR Solvency capital 99.5% Standard model or internal model MCR- absolute minimum capital requirement Pillar 2 System of Governance ORSA own risk and solvency assessment Supervisory review process To assess quality of firm s risk management To determine if add-on capital is required Pillar 3 Private and Public Disclosure Disclosure requirements Forward looking Relevant Public disclosure focused on needs of market participants E.g. annual report on Solvency and Financial Condition. Demonstrating adequate Financial Resources Ensuring an adequate system of governance, aims to embed Solvency II into the business Public Disclosure serves a different purpose from private regulatory reporting of information to supervisors 4

5 Solvency II Pillar 1 s risk based capital framework Structure of the Solvency Capital Requirement under Solvency 2 (SCR) Pillar 1 Quantitative requirements Market-consistent value of assets and liabilities SCR Solvency capital 99.5% Deferred Tax Adjustment Non-Life Insurance SCR Market Risk SCR SCR Basic SCR Health Insurance SCR Counterparty Default Risk SCR Operational Risk SCR Deferred Tax Adjustment Standard model or internal model MCR- absolute minimum capital requirement Pillar One prudence objective for the SCR is to leave less than a 1 in 200 chance that capital will prove inadequate over the next 12 months Premium & Reserve Risk Catastrophe Risk Concentration Risk FX Risk Property Risk Interest Rate Risk Equity Risk Spread Risk Long-Term Health Short-Term Health Workers Comp Illiquidity Risk Catastrophe Risk Revision Risk Mortality Risk Longevity Risk Disability Risk Expense Risk Lapse Risk Source : Morgan Stanley, Oliver Wyman Joint report: The Tide is going out for further details 5

6 SCR Solvency Capital requirement Key characteristics of the standard model Group Solvency Requires the aggregation of capital requirement Eliminates double-counting An allowance for diversification benefits The individual capital requirements for different risks are combined using correlation matrices Market risk Life Risks Market risk is calculated from the impact of specified adverse market stress scenarios. The proposals include a dampener to reduce pro-cyclicality, Life underwriting risk is based on stress-testing the assumptions Stresses largely based on industry averages and expert opinion Non life risk Non-life underwriting risk capital is determined by applying standard factors to premiums and reserves 1. See Oliver Wyman/Morgan Stanley Sept 2010 Joint Report The tide is going out for further details 6

7 Key implications of Solvency II Morgan Stanley / Oliver Wyman proprietary QIS5 model estimates a decline in the solvency ratio for the listed European insurers from ~200% to 135%. Solvency 2 will be a catalyst for a fundamental reappraisal of traditional insurance business models The transparency brought by Solvency 2 will expose the economic volatility of balance sheets We see reinsurers as relative winners, while small insurers including many mutuals may struggle European insurers may become competitively challenged in markets with non- Solvency 2 equivalent regimes Will be a reference model for the IAIS and other jurisdictions reforming their capital frameworks to be congruent with IFRS 4 7

8 International Regulatory Developments - A Canadian Perspective on Capital Allan Brender Special Advisor, Regulation Sector Office of the Superintendent of Financial Institutions Canada December 2, 2010

9 Agenda The current situation w.r.t. financial reporting and capital Introduction of IFRS in Canada Changing capital requirements (MCCSR) Pillar II Own Risk and Solvency Assessment (ORSA) 9

10 The Current Situation Canada uses GAAP statements for regulatory purposes We are committed to one set of financial statements We have had a sophisticated regulatory capital requirement (MCCSR) since 1992 Has been updated from time to time; more can be done Moving towards an advanced approach internal models; our work on this has slowed down due to our experience with models for variable annuities Supplemented by stress and scenario testing (DCAT) 10

11 Introduction of IFRS IFRS comes into effect in Canada on 1 January 2011 All IFRSs adopted verbatim from IASB For insurance, not many significant changes in 2011 Some small adjustments to MCCSR for 2011 because of adoption of IFRS The major challenge and change will come with the introduction of Phase II of IFRS4 on insurance contracts 11

12 IFRS4 Phase II IASB published an exposure draft (ED) this summer Comment period ended on Tuesday, 30 November In principle, the ED is close to Canadian valuation methodology, particularly to the Policy Premium Method (PPM) which was replaced in 1995 by our current Canadian Asset Liability Method (CALM) Assumptions: best estimate plus explicit margin Recognize all policy cash flows (Gross) policy premium basis 12

13 IFRS4 Phase II IASB and IFRS4 will not recognize any link between a company s policy liabilities and the assets it uses to support those liabilities The valuation discount rate is, for many, the main issue with the ED Current Canadian method, CALM, recognizes Cost of expected asset defaults Asset / liability mismatch Therefore, with the introduction of IFRS4 Phase II, required capital (MCCSR) must be adjusted to make complete provision for credit and ALM risks 13

14 Changing Capital Requirements We remain committed to a single set of financial statements However, the capital requirement may not always be based upon numbers in the financial statements Began planning for a new capital requirement in 2005/6 Formed the MCCSR Advisory Committee with industry Slow progress, which came to a standstill with the emergence of the global financial crisis (GFC) 14

15 Effect of the GFC on Variable Annuities Valuation of VAs was primarily based upon the use of internal models Company models were required to be approved by OSFI Since most companies did not sufficiently hedge the financial risks, when equity markets suffered a severe decline, VA liabilities experienced a huge increase, especially since we are dealing with a non-diversifiable risk 15

16 Effect of the GFC on Variable Annuities This VA experience raised two significant issues: The use of company-specific (internal) models Calibration Controls, use test, etc. Recognition of (the absence of) hedging Market consistent methodology 16

17 Adapting MCCSR to IFRS Need a consistent view of liabilities and capital i.e. the right hand side of the balance sheet It is clear that policy liabilities under IFRS4 will not make reference to the particular assets used by an insurer to support those liabilities Therefore, policy liabilities will take no account of credit or ALM risks Provision for these risks must be contained wholly within required capital Work is underway to develop these new pieces for MCCSR 17

18 Redesigning MCCSR Total Asset Requirement Immunize capital structure from changes in accounting into which OSFI has virtually no input Determine the total assets we want an insurer to hold to support a product portfolio Subtract from this total the liabilities determined by financial reporting The balance is required capital (SCR) Need an independent minimum capital requirement (MCR) 18

19 Redesigning MCCSR 19

20 Redesigning MCCSR First, select a time horizon For each risk, select an extreme shock that the insurer should survive over the time horizon Required capital for that risk is the sum of Experience under the shock during the time horizon Difference between the terminal provision and the initial policy liability 20

21 Redesigning MCCSR For Solvency II Time horizon is one year Terminal provision is best estimate liability at the end of the year This is related to the accounting notion of exit value that was being considered by IASB at the time the Solvency II legislation (Directive) was enacted Today, financial reporting is focused on fulfillment value Correspondingly, our approach to capital is changing 21

22 Redesigning MCCSR OSFI is unlikely to introduce correlation between risks Solvency II structure: 22

23 Redesigning MCCSR We will likely return to the question of an advanced approach and the use of internal models Can reflect specific relationships between risks in a model Acceptance of advanced approach by the regulator / supervisor involves acceptance of the possibility that required capital may be less than that produced by a standard approach For this reason, supervisors require pre-approval of models and conditions on their use 23

24 Three Pillar Approach to Solvency Similar for both Basel Committee for Banking Supervision (BCBS) and the International Association of Insurance Supervisors (IAIS) Pillar I: capital requirements Pillar II: company specific Pillar III: disclosure, to encourage market discipline e.g. OSFI requires life companies to disclose an analysis of earnings by source (IASB is moving to this approach for the income statement) 24

25 Pillar II Involves supervisory action on individual company basis Control levels Possible additional requirements Involves company management action Risk management DCAT / stress testing is part of this Own Risk and Solvency Assessment (ORSA) 25

26 ORSA A company should analyze and know the type and degree of risks it faces It should have a view on total capital needs Not just those specified by the regulator /supervisor Economic capital Generally requires a sophisticated internal model IFRS4 Phase II ED seems to assume all companies have such models 26

27 ORSA It would be a serious error to treat ORSA as a compliance exercise Ultimately, regulators are much more interested in companies that are safe, well run and know what they are doing than in having companies merely comply with legal requirements 27

28 Forthcoming IAA Publications The IAA Solvency Subcommittee (of the Insurance Regulation Committee) is preparing two useful and practical papers designed to help actuaries (and others) in this work: A paper on internal models A paper on scenario and stress testing 28

29 International Regulatory Developments Solvency II Equivalence Issues Bob Diefenbacher, FSA, MAAA SVP Life Reinsurance Manulife Reinsurance December 2, 2010

30 Agenda Definition of Equivalence Equivalence and Bermuda Equivalence and the US Transition Countries? 30

31 Background Players Member States = Country subject to Solvency II Third-Country = Country not subject to Solvency II CEIOPS = Committee of European Insurance and Occupational Pension Supervisors Group Supervision Concept that regulators should not just review specific legal entity, but should consider entire corporate structure 31

32 Equivalence Article 172 Article 172 Reinsurance Reinsurance with companies domiciled in equivalent third-countries shall be treated in the same manner as reinsurance with Member States. Article 173 Member States cannot require pledging of assets to obtain reserve credit if equivalent. In the absence of equivalence, treatment of third-country reinsurance would be left to determination of Member States. 32

33 Equivalence Article 227 Article 227 Group Solvency Applies to situations where parent company in a Member State has a subsidiary in a third-country. If subsidiary s country is equivalent, then the group supervisor may rely on solvency requirements and calculations of subsidiary in thirdcountry. Commission may identify certain countries as equivalent. If the commission has not made a determination, then verification of equivalence is determined by the group supervisor, consulting with other authorities. Commission may adopt criteria for determining equivalence. 33

34 Equivalence Article 260 Article 260 Group Supervisor Applies to situations where a company doing business in a Member State has a parent domiciled in a third-country. If parent s third country is equivalent, then Member State supervisor shall rely on the group supervision of the third country. If parent country not deemed equivalent, then Member State can make its own determination of equivalence. Article 261 also references the need for cooperation with thirdcountry regulators. CEIOPS has stressed the importance of setting up cooperation agreements. 34

35 Pro s and Con s of Equivalence Why Would A Country Want Equivalence? Insulates local companies from uncertainty associated with not having equivalence Fair treatment for reinsurance assumed from EU. Protects local reinsurers business model. Avoids potential need for local companies to have to provide information to EU regulator in addition to local regulator. Why Would A Country Not Want Equivalence? May require significant additional investment in resources to achieve equivalence. May require significant changes in existing solvency regime. Local regulator may not agree with every principle of Solvency II. May impact market segments completely unrelated to Solvency II 35

36 Current Status of Equivalence Deliberations CEIOPS recognized that equivalence evaluations will be very labor intensive. CEIOPS recommended the concept of a First Wave of thirdcountries chosen according to criteria based generally on supervisory regime, significance to EU companies, and existence of mutual recognition agreements. European Commission Has Now Instructed CEIOPS to assess 3 Countries in the first wave: Bermuda Articles 172, 227, 260 Switzerland Articles 172, 227, 260 Japan Article

37 Bermuda Bermuda Monetary Authority (BMA) very committed to obtaining equivalence Bermuda is building a complete capital and solvency framework Developing standard formula for required capital Could use internal models, if approved. Assets and liabilities modeled on a consistent basis Enhanced disclosure and governance requirements Drafting group supervision rules Becomes effective (varies by requirement and class of company) BMA working with industry task force to test different alternatives Transitional measures from current regime to new regime to be proposed soon 37

38 US State Based Regulatory System a Challenge CEIOPS Identified Following Issues National Association of Insurance Commissioners (NAIC) not a regulatory body Does act as coordinator, and therefore could be a path to equivalence Group supervision concerns Protection of information subject to state laws, which vary US Industry would point out additional issues Neither NAIC nor individual states can negotiate mutual recognition agreements Newly created Federal Insurance Office might be a solution 38

39 Transition Countries? European Commission has floated the idea of a transitional regime to deal with third-countries not in the first wave. Third-countries chosen for transitional regime would: Have same benefits as equivalence for a limited time period Need to satisfy certain criteria and commit to converging towards fully equivalence by end of period. Need to fully satisfy all equivalence criteria by the end of the time limit US seen as prime candidate for transition. Could also apply to Bermuda, Switzerland, or Japan if deemed not yet ready for full equivalence Transition Still Being Debated in the EU 39

40 Questions? Thank you for your attention