Solvency II: Implementation Challenges & Experiences Learned
Appointed Actuary Symposium Actuarial Society of Hong Kong (ASHK) Jonathan Zhao - Actuarial Services Practice Leader, Asia Pacific 3 November 2010
Agenda
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Solvency II introduction & recap
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Implementation procedures
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Experiences & lessons from QIS 5
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Looking ahead
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Appointed Actuary Symposium: Actuarial Society of Hong Kong
Solvency II introduction & recap
►
Solvency II introduction & recap
►
Implementation procedures
►
Experiences & lessons from QIS 5
►
Looking ahead
Page 3
Appointed Actuary Symposium: Actuarial Society of Hong Kong
Solvency II introduction & recap Background ►
Solvency II is the proposed new Europe-wide framework for prudential supervision of insurance
►
Aims to address problems with Solvency I - Outdated system - Insufficiently risk-sensitive - Does not reflect best practice - Difficulties in supervising multinational, diversified groups
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A fundamental change to Solvency requirements: - Principles based approach to supervision - Market consistent approach for valuing liabilities - Capital requirements linked to risk profile - Convergence of economic capital and regulatory capital - Major focus on risk management - Significant disclosure requirements - Capital add-ons for deficiencies - Links to other reporting measures
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Appointed Actuary Symposium: Actuarial Society of Hong Kong
Solvency II introduction & recap We are here
Regulatory timeline and implementation activities
2009 May 2009 – Framework Directive Approved
European
CEIOPS/ > EIOPA >
Regulatory timetable
QIS5 feedback
2012 October 2011 – Level 2 Directive Approved
Internal Model Application Process (IMAP) submission
Legislative process
Impact study of L2 (Commission)
Planning for implementation in 30 countries and associated territories
Interactive – firms & FSA
Vision & Gap analysis
Road Map design
Implementation – 31 December 2012
Develop guidance under Level 3
L2 drafting (Commission and EIOPC)
UK
Implementation activity
QIS5
Level 2 advice to Commission
Member States
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2011
2010
IMAP dry run (June 2010 to October 2011)
Transposition into domestic law and regulation IMAP by April 2012
Full implementation
Build and test Detailed Implementation design
Embed Implementation
Appointed Actuary Symposium: Actuarial Society of Hong Kong
Solvency II introduction & recap Frame work – 3 Pillar Approach
Risk Quantifications
Risk Management
Risk Transparency
Pillar 1
Pillar 2
Pillar 3
Quantitative Capital Requirements
Supervisory activities
Supervisory reporting & public disclosure
Risk Governance
Transparency & Disclosure
Solvency Capital Requirements (SCR) Minimum Capital Requirements (MCR)
A risk oriented framework
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Appointed Actuary Symposium: Actuarial Society of Hong Kong
Pillar 1
Pillar 1
Pillar 2
Pillar 3
Technical Provisions
Risk Management
MCR Minimum Capital Requirement
Own Risk and Solvency Assessment (ORSA)
DisclosureSolvency & Financial Condition Report
SCR Solvency Capital Requirement
Supervisory powers & processes
Market Discipline
Model Approval
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Appointed Actuary Symposium: Actuarial Society of Hong Kong
Solvency II – Pillar 1 Market consistent balance sheet The starting point for Solvency II is an economic, market-consistent approach to the valuation of assets and liabilities. Alignment as far as possible between Solvency II and IFRS 4 Phase II. Solvency II Balance Sheet
Free Surplus
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Assets are valued at market value
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Technical provisions = BEL + Risk Margin Best Estimate Liability (BEL) ► Best estimate of all future cash flows discounted at a risk free rate with adjustment for illiquidity premium ► Risk free rate is derived from swap rates less an adjustment for credit risk (10bps), level of illiquidity premium various by contract type (50bps – 100bps) + Risk Margin ► Cost of capital method will 6% factor used for QIS 5, IFRS 4 Phase II suggested 3 methods (CI, CTE and CoC)
Own Funds SCR
MCR
Assets
Risk margin
Technical provisions
Best estimate liability
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Capital requirements ► ► ►
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SCR = first regulatory intervention point (VaR @99.5% CI over 1 year) – Standard Formula or Internal Model MCR = final regulatory intervention point (VaR @85% CI over 1 year) Framework directive has also set MCR to a minimum of 25% and a maximum of 45% of the SCR
Appointed Actuary Symposium: Actuarial Society of Hong Kong
Solvency II – Pillar I Structure of standard formula for SCR SCR = BSCR + Adj + Op Risk Adj
Market
Def ault
Health
Interest rate
SLT Health
Equity
BSCR
Health CAT
Operational Risk
Lif e
Non-Lif e
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SCR intangibles risk module introduced for QIS 5.
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SCR illiquidity premium sub-module introduced for QIS 5.
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Health risk module split between SLT (similar to life techniques) and NonSLT – some reduction in QIS5 for certain correlations between sub-module risks. Health CAT risk introduced (as per Final Advice although the CAT risk is now aggregated across SLT and NonSLT).
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A lapse risk module for Non Life business has been introduced to recognise the impact if policy take-up rates were lower than expected.
Intangibles
Non-SLT Health
Mortality
Premium Reserve
Mortality
Premium Reserve
Longevity
Lapse
Property
Longevity
Lapse
Disability Morbidity
CAT
Spread
Disability Morbidity
Currency
Lapse
Concentration
Expenses
Revision
Illiquidity
Revision
CAT
Lapse
Basic SCR correlations
Expenses
Market
Life
Health
Market
1
Default
0.25
1
Life
0.25
0.25
1
Health
0.25
0.25
0.25
1
Non-Life
0.25
0.5
0
0
= included in the adjustment f or the risk mitigating ef f ect of future prof it sharing
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Default
Appointed Actuary Symposium: Actuarial Society of Hong Kong
Non-Life
1
Solvency II - Pillar 2
Pillar 1
Pillar 2
Pillar 3
Technical Provisions
Risk Management
MCR Minimum Capital Requirement
Own Risk and Solvency Assessment (ORSA)
DisclosureSolvency & Financial Condition Report
SCR Solvency Capital Requirement
Supervisory powers & processes
Market Discipline
Model Approval
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Appointed Actuary Symposium: Actuarial Society of Hong Kong
Pillar 2 Requirements ►
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The key requirement of Pillar 2 is for firms to have a system of governance to “provide for sound and prudent management of the business”. This system of governance “shall at least include an adequate transparent organisational structure with a clear allocation and appropriate segregation of responsibilities and an effective system for ensuring the transmission of information”. Supporting this requirement are six key “aspects” based on conditions and functions which the Directive expects Firms to address and have in place:
Conditions ► Fitness and Propriety ► Outsourcing ► Internal Control Functions ► Risk Management Function ► Internal Audit Function ► Actuarial Function Pillar 2 can be split in two – Governance and ORSA
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Evidencing Successful Pillar 2 Implementation Governance ► Clear and documented delegation of authority cascading through the organisation with appropriate spans of control and suitable persons holding roles ► Suitable allocation of function responsibility that avoids duplication ► Clear articulation of committee responsibilities split between “doing” and “oversight” and “assurance”. ► Policies that set out how the business is overseen and controlled and that reflect the current reality ► Risk information to support individuals and committees in their roles across the lines of defence Own Risk and Solvency Assessment (ORSA) ► A demonstrable strategy and appetite for risk that is cascaded down through the organisation ► A process for identifying all the risks to the business, quantifying them across a range of outcomes controlling them and reporting within them within the governance arrangements set out ► A dynamic approach to using risk information within the business on a timely basis
Appointed Actuary Symposium: Actuarial Society of Hong Kong
Pillar 2 Own Risk and Solvency Assessment The ORSA is the regular practice of assessing overall capital needs with a view to the firm’s specific risk profile that forms part of the risk management system. It is: ► an internal assessment process and as such should be embedded in strategic decisions, and ► a supervisory tool for the supervisory authorities.
“3 lines of defence” model – a possible approach to meet Solvency II requirements Board Strategy, risk appetite and policy
The ORSA can be defined as the entirety of the processes and procedures employed to identify, assess, monitor, manage, and report the short and long term risks that the business faces or may face and to determine the own funds necessary to ensure that its overall solvency needs are met at all times. The ORSA aims at enhancing awareness of the interrelationships between the risks the business is currently exposed to, or may face in the long term, and the internal capital needs that follow from this risk exposure. The ORSA needs to be supported by an effective and robust escalation process paying particular attention to
Functional escalation ► Risk exposures and the linkages to decision making ►
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1st
Line
Risk Ownership
2nd Line
3rd Line
Risk Control and Monitoring
Independent Assurance
Executive Committee
Oversight Committee
Audit Committee
Supported by Risk Taking Business Units
Supported by Compliance, Actuarial, Risk Management and Risk Modelling Functions
Supported by Internal Audit
Risk Management Systems Own Risk and Solvency Assessment Internal Control Framework
The ORSA process for assessing and monitoring overall solvency builds on the Pillar I SCR calculation by articulating the firm’s view of required capital. It should form an integral part of the business planning of the organisation. A key challenge will be integrating the appropriate modelling approaches into the risk framework and ORSA.
Appointed Actuary Symposium: Actuarial Society of Hong Kong
Solvency II - Pillar 3
Pillar 1
Pillar 2
Pillar 3
Technical Provisions
Risk Management
MCR Minimum Capital Requirement
Own Risk and Solvency Assessment (ORSA)
Disclosure - Solvency & Financial Condition Report
SCR Solvency Capital Requirement
Supervisory powers & processes
Market Discipline
Model Approval
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Appointed Actuary Symposium: Actuarial Society of Hong Kong
Pillar 3 Overview Three aspects: Report to Supervisor – RTS Information to submit to regulator ► ► ►
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Solvency and Financial condition report - SFCR Public disclosures – at least annually
Disclosures by regulators
RTS and SFCR will contain a qualitative report, including quantitative data and quantitative reporting templates Proportionality principle: detail of information is in line with nature, scale and complexity of risks inherent in the business Need a written disclosure policy approved by the management body to ensure appropriate governance procedures and practices so that information is complete, consistent and accurate (on an ongoing basis) There are provisions to avoid competitors of the undertaking gaining significant undue advantage – non-disclosure of information in specific cases need to be explicitly mentioned (along with reasons) in the SFCR In the SFCR, you may refer to or make use of equivalent information available elsewhere in the public domain (although CEIOPS do not consider it appropriate to refer through hyperlinks to other documents - rather reference if further information is provided elsewhere)
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Appointed Actuary Symposium: Actuarial Society of Hong Kong
Implementation procedures
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Solvency II introduction & recap
►
Implementation procedures
►
Experiences & lessons from QIS 5
►
Looking ahead
Page 15
Appointed Actuary Symposium: Actuarial Society of Hong Kong
Some key questions regarding your Solvency II implementation 2009 May 2009 – Framework Directive Approved
Implementation activity
2011
2010 QIS5
QIS5 feedback
Planning for implementation in 30 countries and associated territories
IMAP dry run (June 2010 to October 2011)
Vision & Gap analysis
Road Map design
Detailed Implementation plan and activities
2012
Internal Model Implementation – Application 31 December 2012 Process (IMAP) submission Transposition into domestic law and regulation
IMAP by April 2012
Full implementation
Build and test Embed Implementation
► What level of detail does your implementation plan go to? (e.g., high-level road map and detail activity plan) ► Does your plan build on the output from the gap analysis and identified solutions to mitigate all deficiencies? ► Has your plan been reviewed and approved by the governance committee, with agreed budget, headcounts, and timeline that are realistic? ► What do you plan to do next with your plan? Page 16
Appointed Actuary Symposium: Actuarial Society of Hong Kong
Illustrative SII governance and program structure – ’making it happen’ A well defined SII governance/program structure will ensure rapid decision-making, and effective execution of the SII implementation plan Program Governance
Key Features ►
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Horizontal & vertical workstreams to drive aligned business requirements and a complete business case
Steering Committee
Technical Review Panel
Program Directorate
Design Authority Team
Dedicated technical challenge and support at all levels of the program
Program Management
Program Management Office
Workstreams Internal Model
Risk & ORSA
Reporting & Disclosures
Optimisation
Technology/Data and Tools Enabling Workstreams
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Process & Controls Change Management Documentation
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Appointed Actuary Symposium: Actuarial Society of Hong Kong
Product Pricing and Development
Resourcing for SII and understanding its implications on existing headcount 30
SII headcount means a x% growth
25 6
5
20 4 15
2 3 1
3
10 15 5
16 12
10
1 3 4
0 Analyst
Senior Analyst Current team
Assistant Manager
Manager
Open positions
Senior Manager SII resources required
Considerations on resourcing: ►
Where to hire resources from?
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Internal vs. external use of resources and its cost implications?
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Impact on existing headcount and integrating new resources into business as usually activities?
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Speed at which resources can be obtained? Impact on SII programme?
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When do the resources need to be brought it? All at a point in time? Spread over time?
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Appointed Actuary Symposium: Actuarial Society of Hong Kong
2 Director
Example of Detailed Road Map – Risk Modelling & Reporting Phase 1 Understand & Design SII Reporting Metrics & Modeling Requirements
2H 2009
SII Reporting Methodology
Overall SII Reporting Framework ALM Model
1H 2010
1
2H 2010
4 5
QIS5 Solo delivery by Oct 2010
6 7
Phase 2 – SII Reporting Implementation and Testing Phase 3 Transition from Development to Production Page 19
Implementation of the internal model
8
ESG
Internal Finalisation of Models & External Model Audit
Business As Usual
3
ALM Modeling
Validation, documentation & User Testing
2H 2012
2
Asset Valuation Implementation
Financial Reporting Infrastructures
1H 2012
Define and document required enhancement to models to meet requirements
Economic Scenario Generator (ESG) Complete QIS5
2H 2011
1H 2011
9
Complete design and implement of valuation processes and reporting
10 11
External Audit Process being Carried Out
12
SII Reporting Full Testing & Dry Runs SII Reporting System Go Live
Parallel runs of Q1 ~ Q3 2012
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Appointed Actuary Symposium: Actuarial Society of Hong Kong
System launched
Example of Detailed Road Map – Risk Management
Review of Governance
Review of Risk Appetite & Tolerance Limits
2H 2009
1H 2010
2
Set Risk Tolerances per Major Risk Category
3
Define Management Response to Risk Identification and Appetite Define Control Activities to Address Risk Management requirements
Build Process Catalogue
Embed Risk Management Changes
Review of ORSA
Define and Design Process
6 7
Embedding Change Management Programs Completed
8
Design of ORSA Process Completed
Final Documentation of Operational Risks Completed
Assessment of other Risk categories
10
Use Test
Definition of Control Activities Completed
5
9
Define Independent Review of ORSA
2H 2012
Definition of Management Response to Risk Management Completed
4
Identify and Assess Operational Risks
Build ORSA Report Formats
1H 2012
2H 2011
Definition of Risk Appetite Completed Allocation of Risk Tolerances per Major Risk Category Completed
1
Define and Determine Risk Appetite
Assess / Update Governance Manuals, Terms of Reference and Role Definitions
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1H 2011
2H 2010
Final Documentation of Other Risk Categories Completed
11 12
Definition of Independent Review of ORSA Completed
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Appointed Actuary Symposium: Actuarial Society of Hong Kong
Use Test Complete
Business As Usual
Annually review and update as required
The biggest issue/difficulty faced by company in its Solvency II implementation ►
Resource, resource, resource !!!
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Understand the scale and complexity of the SII project and reflecting it realistically in the time, resource and cost estimate
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Deciding the appropriate detail action plans for both short term and medium to long term activities, including the key workstream leaders and SII program structure
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Allowing flexibility to cope with surprises arising from the Level 2 Implementing Measures and Level 3 Guidance
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Allowing for hand-offs and dependencies between workstreams and different department
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Other
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Appointed Actuary Symposium: Actuarial Society of Hong Kong
Experiences & lessons from QIS 5
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Solvency II introduction & recap
►
Implementation procedures
►
Experiences & lessons from QIS 5
►
Looking ahead
Page 22
Appointed Actuary Symposium: Actuarial Society of Hong Kong
Experiences & lessons from QIS 5 QIS 5 Overview Overview ►
The final QIS5 Technical Specification was issued on 6 July 2010 after discussions on the Draft Specification with selected stakeholders (CEA, AMICE, CRO Forum, CFO Forum, ECIROA, FERMA and Groupe Consultatif).
►
The Commission has emphasized the importance of dealing with all areas of the exercise comprehensively, and is expecting high quality submissions from firms on which to base its decisions.
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A number of key changes from the draft technical spec: ►
Changes in calibrations – generally less favourable compared to QIS4, but more favourable compared to CEIOPS Consultation Papers / Final Advice.
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Changes in methodology – additional sub-modules proposed and refinements in methodology for existing (sub)modules compared to QIS4.
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The technical specifications should not be seen as the final outcome as the intention is to publish the Level 2 implementing measures once the results of QIS5 are known.
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Results not required to be submitted to OCI.
QIS5 objectives ►
To provide detailed information on the quantitative impact of future Level 2 implementing measures .
►
To encourage industry preparation and to: ►
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Identify areas where internal processes, procedures and infrastructure may need to be enhanced and encourage improvements to data collection processes
To provide a starting point for an ongoing dialogue in preparation for the new supervisory system.
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Appointed Actuary Symposium: Actuarial Society of Hong Kong
QIS5 provides an ideal checkpoint for Solvency II programmes to: ►
Educate stakeholders with quantitative evidence of the potential impacts, informing lobbying activity.
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Review and realign Solvency II plans based on your experience of performing QIS5.
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Extending the dialogue between local operating companies and European parent.
Experiences & lessons from QIS 5 Issues & Challenges - Overview Key issues and challenges encountered while carrying out QIS 5 exercise: ►
Application of contract boundary condition.
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Calculation of expected profits in future premiums (“EPIFP”).
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Calculation of risk margin.
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Severity of standard formula currency risk stress.
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System and resource limitations.
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Appointed Actuary Symposium: Actuarial Society of Hong Kong
Experiences & lessons from QIS 5
Issues & Challenges – Contract Boundary
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Definition of contract boundary as per QIS 5 Technical Specifications: ►
where an undertaking has the unilateral right to terminate the contract; or
►
where an undertaking has the unilateral right to reject premiums; or
►
where an undertaking has the unilateral right to amend premiums or benefits,
at some point in the future, then any cash flows pertaining to time period after that date should not be included in the liability calculations. ►
For insurers in the region, yearly renewable business likely to be affected.
►
Likely to affect the BEL negatively as these business tend to have a negative BEL value.
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Current debate on application of contract boundary unit-linked contracts.
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Companies might calculate (submit) two set of results (one follow QIS 5 guidance exactly, and one follow their interpretation) given the definition of contract boundary is unclear
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Appointed Actuary Symposium: Actuarial Society of Hong Kong
Experiences & lessons from QIS 5
Issues & Challenges – EPIFP Calculation ►
QIS 5 introduces the concept of expected profits in future premiums (“EPIFP”).
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Explicit recognition of expected profits built into future cash flows on best estimate basis.
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EPIFP value is to be included as Tier 1 capital for Own Funds calculations.
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Methodology for calculating EPIFP: ►
Calculate technical provisions (ex-risk margin) using best estimate assumptions. [A]
►
Calculate technical provisions (ex-risk margin) assuming no future premiums are received. [B]
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Technical provision (ex-risk margin) from [B] less that from [A] is the EPIFP value (if negative, EPIFP set to zero).
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In calculating [B], benefit levels are adjusted to be consistent with assumption of no future premiums. This adjustment not trivial as use of retrospectively or prospectively calculated surrender benefits will include elements of past or future profits.
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Severity of issue depend on reliance on EPIFP to meet the required capital requirements.
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Appointed Actuary Symposium: Actuarial Society of Hong Kong
Experiences & lessons from QIS 5
Issues & Challenges – Risk Margin Calculation ►
Recall - risk margin calculation is a cost of capital approach, where the capital is the projected SCR. Projected SCR to include: ►
unavoidable market risk;
►
life underwriting risk;
►
counterparty default risk relating to reinsurance and SPV reinsurance arrangements; and
►
operational risk.
►
Projection of the SCR requires nested stochastic calculations – stresses to be applied for each future time period.
►
Possible modeling solutions being explored include replicating portfolios and formula fitting techniques.
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Meanwhile, QIS 5 technical specifications set out a number of simplifications. Hierarchy of simplifications: ►
full calculation of projected required SCR (no simplification used);
►
approximate only certain risks in some of the required SCR;
►
approximate whole SCR for each future year;
►
approximate all future required SCR “at once”;
►
approximate risk margin as a percentage of the best estimate liabilities.
►
In deciding simplification to be used, need to consider the information, resources and modeling capability available.
►
May impact the capital position of the firm as risk margin could be a material value.
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Appointed Actuary Symposium: Actuarial Society of Hong Kong
Experiences & lessons from QIS 5
Issues & Challenges – Currency Risk Stress
►
Standard formula stress for currency stress is an increase and decrease of 25% in net foreign currency exposure.
►
This calibration may not be suitable for the Hong Kong dollar /United States dollar relationship given the close relationship of the two currencies in recent history.
►
Some participants are viewing this as being too penal.
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Likely to have a significant impact on the SCR calculations.
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Appointed Actuary Symposium: Actuarial Society of Hong Kong
Experiences & lessons from QIS 5
Issues & Challenges – System and Resource
►
System limitations: ►
Data systems not able to support the extraction of data at the expected level of granularity required for Solvency II Pillar 1 compliance. ►
►
Modeling capabilities not sufficiently refined to model key liability and asset portfolio features. ►
►
Example – historical and forecast premium information by line of business.
Example – dynamic policyholder behavior and equivalent scenario.
Resource limitations: ►
Lack of buy-in from management due to submission to OCI not required. ►
►
Lack of personnel with the relevant knowledge/experience. ►
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Possible solutions: educate stakeholders; build relevant Solvency II features into business as usual activities.
Possible solutions: tap knowledge of colleagues in European HQ; start recruiting and training now; engage consultants for specific modules.
Appointed Actuary Symposium: Actuarial Society of Hong Kong
Looking ahead
►
Solvency II introduction & recap
►
Implementation procedures
►
Experiences & lessons from QIS 5
►
Looking ahead
Page 30
Appointed Actuary Symposium: Actuarial Society of Hong Kong
Looking ahead Expected Implementation Challenges as SII Progress Use test
Significant business changes
► This will be one of the most challenging areas of the new regime ► The impact will be far reaching and as a result the implementation challenges will be significant
► In the end state of Solvency II, there will be significant changes to the models, management information, data, infrastructure and procedures ► There are commercial and profitability implications arising out of implementation
Implementation challenges Links to other projects
Cultural changes
► Solvency II can potentially link directly or impact on projects already ongoing.
► Changes in the culture would be required to reflect new metrics and processes
► Ensuring that work done in these workstreams is leveraged appropriately to ensure no duplication of effort will be a key role of the Solvency II Steering Group.
► There is a necessity to manage the business to different metrics consistently across the group…
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► …and to reward people on the basis of these new metrics.
Appointed Actuary Symposium: Actuarial Society of Hong Kong
Looking ahead Impact from IFRS 4 Phase II
Page 32
3 September 2009
Training Materials
Thank You Appointed Actuary Symposium 3 November 2010
