Capital management in a Solvency II world: A non-life perspective

November 12th, 2014 No comments

Insurance and reinsurance companies have charted a new approach to capital management. The financial crisis has shown that undertakings cannot assume that capital will be readily available as and when it is needed and, even if it is available, it may not be accessible at the right price. Solvency II will change the way insurance and reinsurance undertakings determine their regulatory capital requirements, as well as introduce new rules with regard to what forms of capital can be used to meet those requirements. As a result, Solvency II will bring about both challenges and opportunities for undertakings. This paper aims to address some of the key issues for insurers and reinsurers with regard to capital management in a Solvency II world.

Solvency II standard formula – U-turn from the Commission on operational risk module capital for unit linked business

October 15th, 2014 No comments

On 10th October 2014 the European Commission adopted a Delegated Act containing implementing rules for Solvency II. This Delegated Act has now been sent to the European Parliament and Council for approval which could take up to a maximum of 6 months.

A recent draft version of the Delegated Act (dated 28th July 2014) contained a suggested controversial change to the operational risk capital for unit linked business. The operational risk capital for unit linked business under the standard formula is set at 25% of unit linked expenses. However, the definition of expenses had been adjusted to include acquisition expenses (including initial commission). It was expected that this change would lead to large increases in capital requirements for many unit linked insurers particularly as commission payments could be a multiple of expenses for some companies.

Insurers of unit linked business may now breathe a sigh of relief as the Commission have since revoked this change. Note 67 of the opening remarks of the Delegated Act adopted this week refers to the operational risk module and states:

“In view of the fact that acquisition expenses are implemented heterogeneously in different insurance business models, these expenses should not be taken into account in the volume measure for the amount of expenses incurred during the previous 12 months.”

Footnote:
Acquisition expenses are defined in EIOPA Consultation paper on the proposal for Guidelines on Solvency II relating to Pillar 1 requirements dated 2 June 2014 as: “2.52 Acquisition expenses include expenses which can be identified at the level of individual insurance contract and have been incurred because the undertaking has issued that particular contract. These are commission costs, costs of selling, underwriting and initiating an insurance contract that has been issued.”

If you have any questions or comments on this eAlert or any other aspect of Solvency II, please contact your usual Milliman consultant.

To read our past eAlerts, click here, or visit our Solvency II documents here.

Solvency II standard formula – increase in operational risk module capital for unit linked business

On 28th July 2014 the European Commission circulated an updated draft of the Solvency II Delegated Acts to Member States. The latest draft of the Delegated Acts includes a change to the standard formula operational risk module for unit linked products. As in previous drafts, the operational risk capital for unit linked business under the standard formula had been set at 25% of unit linked expenses. However, the definition of unit linked expenses in the latest draft Delegated Acts is:

• “Amount of expenses incurred during the previous 12 months in respect of life insurance contracts where the investment risk is borne by policyholders.”

This compares with the definition of unit linked expenses in the technical specification released by EIOPA in April 2014 for the purpose of completing stress tests which was:

• “Amount of expenses incurred during the previous 12 months in respect of life insurance where the investment risk is borne by the policyholders, excluding acquisition expenses.”

So, based on the latest draft Delegated Acts, companies writing unit linked business will now be required to include related acquisition expenses (including initial commission) in the operational risk capital calculation when using the standard formula. This change may result in a significant increase to the operational risk capital and thus the SCR for certain companies.

Footnote:
Acquisition expenses are defined in EIOPA Consultation paper on the proposal for Guidelines on Solvency II relating to Pillar 1 requirements dated 2 June 2014 as:

“2.52 Acquisition expenses include expenses which can be identified at the level of individual insurance contract and have been incurred because the undertaking has issued that particular contract. These are commission costs, costs of selling, underwriting and initiating an insurance contract that has been issued.”

If you have any questions or comments on this eAlert or any other aspect of Solvency II, please contact your usual Milliman consultant.

Visit our website to access our Solvency II documents. Also, to read past eAlerts, click here.

Disclaimer
This e-Alert is intended solely for educational purposes and presents information of a general nature. It is not intended to guide or determine any specific individual situation and persons should consult qualified professionals before taking specific actions. Neither the authors, nor the authors’ employer, shall have any responsibility or liability to any person or entity with respect to damages alleged to have been caused directly or indirectly by the content of this e-Alert.

Milliman Solvency II Readiness Assessment Tool first industry survey: Ireland – Life Assurance

August 13th, 2014 No comments

Milliman developed the Solvency II Readiness Assessment Tool to help companies prepare and plan for Solvency II. The tool is designed for life and nonlife direct writing and reinsurance companies. It enables companies to rate themselves using a range of detailed questions covering the full scope of Solvency II. A score of 5 identifies areas that are 100% ready, whereas a score of 1 identifies areas where no progress has been made.

Thirteen life companies based in Ireland shared their current levels of preparedness. In this briefing, Milliman’s Andrew Kay and Mike Claffey have consolidated the results to give an overall idea of the issues facing companies.

Capital management in a Solvency II world

July 18th, 2014 No comments

Solvency II will change the way insurance and reinsurance undertakings determine their capital requirements as well as introducing new rules with regard to what forms of capital can be used to meet those requirements.

This paper by Eamonn Phelan, Scott Mitchell, and Sinead Clarke addresses some of the key issues, including the need for a robust decision-making framework, how investment strategy fits in, uses of reinsurance, and the new regulatory landscape. The paper also outlines Pillar II and Pillar III requirements.

PRA publications on recognition of deferred tax and data collection exercises

April 17th, 2014 No comments

On 16 April 2014 the UK Prudential Regulation Authority (“PRA”) published Supervisory Statement SS2/14 “Solvency II: Recognition of deferred tax” which sets out the PRA’s expectations of firms regarding the recognition of deferred tax in Solvency II. The supervisory statement outlines the PRA’s expectations in relation to the credibility of projected future taxable profits, as well as highlighting areas to which firms should pay particular attention when considering whether they can:

• Recognise deferred tax assets (“DTAs”) on their Solvency II balance sheets;
• Recognise the loss-absorbing effects of DTAs when performing 1/200 shocks to calculate the solvency capital requirement (“SCR”).

The supervisory statement is aimed at all insurance companies that will be subject to Solvency II, including both internal model and standard formula firms, and reflects feedback that was received by the PRA in response to a public consultation carried out during February and March 2014.

The guidance contained in the supervisory statement, in particular around the projection of future taxable profits to calculate the value of DTAs, serves as a useful clarification of the current Solvency II level 2 guidelines in these areas. However, areas of uncertainty remain, in particular in relation to the basis that firms should use for determining the future profit projections.

PRA summary of Solvency II data collection exercises

On 14 April 2014 the PRA published a summary of the data collection exercises it intends to request from firms during 2014. The main focus of these exercises is to support the transition to Solvency II and aid in preparations for the new regime. A summary of the data collection exercises is given below.

Solvency II briefing

These data collection exercises are similar to those performed in previous years. The most significant difference is the requirement for non-IMAP firms to take part in the SCR comparison exercise (only IMAP firms were required to participate in this exercise in 2013).

The PRA asks firms to be aware that these exercises are in addition to any data collection exercises which may be requested by the European Insurance & Occupational Pensions Authority (“EIOPA”) and that the timing of the SCR comparison exercise is depended on the publication of EIOPA’s Technical Specifications for the Preparatory Phase (due at the end of April 2014), which firms must use when calculating the various elements of their Solvency II balance sheet.

The PRA state that the data collection exercises for 2015 are yet to be determined. Any additional exercises will be to support the submission of information that the PRA expects from firms that are in-scope to report under EIOPA’s preparatory guidelines. The PRA also state that they will make further information available in Q3 2014 regarding National Specific Templates for reporting.

Copies of Solvency II summary papers, together with copies of papers on other topics published by Milliman, can be found on our website.

We look forward to hearing from you if you have any questions or comments on this briefing or any other aspect of Solvency II.

Please contact your usual Milliman consultant, or email SolvencyII@milliman.com for more information.

Disclaimer
This e-Alert is intended solely for educational purposes and presents information of a general nature. It is not intended to guide or determine any specific individual situation and persons should consult qualified professionals before taking specific actions. Neither the authors, nor the authors’ employer, shall have any responsibility or liability to any person or entity with respect to damages alleged to have been caused directly or indirectly by the content of this e-Alert.

A pragmatic approach to modelling real-world interest rates

March 14th, 2014 No comments

Even without the advent of Solvency II and the appeal of internal models to model capital more accurately, it’s likely that the events following the global financial crisis (GFC) would have sharpened up European insurance companies’ risk modelling capabilities.

In Asia, insurance companies are also investing significant resources in developing their own economic capital models. Boards of directors have been charged with the measurement of risk and the need to plan their capital requirements through such things as an Own Risk and Solvency Assessment (ORSA) and an Internal Capital Adequacy Assessment Process (ICAAP) in Singapore and Malaysia, respectively.

Much has already been written about building complex Monte Carlo engines to calculate risk measures. This report by Milliman’s Clement Bonnet and Nigel Knowles addresses a question about the front-end of the risk measurement process: How do we project our yield curve?

Milliman Asia ERM Newsletter, February 2014

February 20th, 2014 No comments

This Milliman Asia ERM Newsletter highlights the latest developments in enterprise risk management (ERM) across the Asia Pacific region. ERM activity in the insurance sector is accelerating at a rapid pace around the region, especially since a number of regulators have introduced Own Risk and Solvency Assessments (ORSA). Even in countries where ORSA has not been introduced yet, there is an increased interest among risk managers who realize the value that ERM can add to their business through enhanced business resilience.

The newsletter features regulatory and market developments related to ERM from India, Singapore, and Thailand. An article by Neil Cantle on the complexity of risk within businesses is also included.

EIOPA announces more details on 2014 Europe-wide insurance stress test

January 23rd, 2014 No comments

In October 2013, the European Insurance and Occupational Pensions Authority (EIOPA) announced its intention to undertake stress testing of the European insurance industry in its 2014 work plan. They have now (20th January) updated their website to give more details on this insurance stress testing exercise.

The stress testing exercise is expected to include:

• Market risks under a combination of historical and hypothetical scenarios
• Insurance risks
• Impacts of low yields and low interest rates

EIOPA plans to consult with the industry in March 2014 and launch the Europe-wide stress test exercise by 30 April. National Supervisory Authorities (“NSA”) will collect and validate submissions by 20 June for onward submission to EIOPA. EIOPA currently expects to publish the results in November 2014.

As in previous stress testing exercises, each local NSA will be responsible for identifying and contacting individual insurers for inclusion in the exercise. It is not clear at this stage which insurers will be asked to participate in the stress testing exercise.

A link to the EIOPA 2014 insurance stress testing timetable and process is here.

If you have any questions or comments on this eAlert or any other aspect of Solvency II, please contact your usual Milliman consultant.

Disclaimer
This e-Alert is intended solely for educational purposes and presents information of a general nature. It is not intended to guide or determine any specific individual situation and persons should consult qualified professionals before taking specific actions. Neither the authors, nor the authors’ employer, shall have any responsibility or liability to any person or entity with respect to damages alleged to have been caused directly or indirectly by the content of this e-Alert.

Recapping insurance industry’s 2013 with a look ahead to 2014

January 7th, 2014 No comments

In this interview with InsuranceERM (subscription required), Milliman’s Neil Cantle and Elliot Varnell reflect on key issues impacting Europe’s insurance industry in 2013. They also discuss some challenges the industry may face in 2014.

Here’s an excerpt from the interview:

What will 2013 be remembered for?
Varnell: I would suggest that it was the year that Solvency II was finally “agreed” at the top level after a few years of debate and wrangling between the Council, Commission and Parliament.

Ironically, it was also the year when economically based regulatory capital was to some extent de-emphasised as the PRA published on Early Warning Indicators (see IERM, 4 October) and the FSB announced its G-SII list (see IERM, 19 July) and kicked off a project through the IAIS to come up with a global metric for regulatory capital (see IERM, 12 December.)

But also the year that many insurers – especially life insurers – rebalanced their focus away from Solvency II and regulatory capital and turned to looking for the best opportunities for value creation in their business. The refocus on product development and investment in infrastructure stand out as examples of areas that insurers have re-focused onto value creation.

What will be the biggest ERM challenge of 2014?
Cantle: I think many firms are still struggling to bring ERM to life and make it truly operational. If ERM is done simply as a compliance exercise then it can cost a lot of money and simply be a burden. If it is done to bring insights to the business and improve the opportunity for discussion about performance uncertainty then it can improve resilience and add significant long-term value to the business. The challenge is therefore to look beyond templates and documentation and make it strategic. Concepts like risk appetite require a multi-variate view of performance, so that indicators are seen in context, and many firms still cannot do that.