1. Solvency II & Captives

2. Solvency II Speakers: Jonathan Groves, Senior Vice President, Marsh UK Limited Shelby Weldon, Director, Insurance Licensing and Authorisation, Bermuda Monetary Authority Vlad Uhmylenko, Director Standard and Poor’s Moderator: Scott Gemmell, Senior Vice President, Marsh’s Captive Solutions Group

3. Solvency II & Captives Jonathan Groves Senior Vice President Marsh UK Limited

4. Solvency II What is it trying to do? Further better regulation by: Enhance policyholder protection –Existing rules lack risk sensitivity Deepen the single market –Restrictions on proper functioning of the single market in insurance –Inefficient supervision of groups Improve (international) competitiveness of EU insurers –International accounting and regulatory developments i.e. IFRS Phase 2

5. Solvency II What is it? Pillar 1: quantitative requirements 1. Harmonised calculation of technical provisions 2. "Prudent person" approach instead of current quantitative restrictions 3. Two capital requirements: the Solvency Capital Requirement (SCR) and the Minimum Capital Requirement (MCR) Pillar 2: qualitative requirements and supervision 1. Qualitative requirements to cover risks which are not captured in the SCR 2. Enhanced internal control, governance, and risk management + solvency self-assessment 3. Strengthened supervisory review, harmonised supervisory standards and practices Pillar 3: prudential reporting and public disclosure 1. Common European reporting tools 2. Public disclosure of the financial condition and solvency report (market discipline, as participants prefer sound healthy companies) Group supervision and cross-sectoral convergence Comes into effect on October 31, 2012 (but unofficially expected to be January 1, 2013)

6. Solvency II When is it being implemented? 2010 Omnibus Directive II CEIOPS: Work on the technical details for implementing measures/ supervisory convergence/Level 3 guidance/Binding technical standards 2006 2007200820092010 20112012 Negotiation & adoption of Directive Proposal (Council & Parliament) Implementation preparation (Member States) QIS 2 July 2007 Directive Proposal QIS 3 QIS 4 April-July 2008 Commission: Preparation of implementing measures Adoption of implementing measures QIS 5 August-Nov 2010 November 2009 Directive adopted Development of Directive (Commission)

7. Proportionality principle Scale ComplexityNature Solvency II Proportionality principle The Directive should not be too burdensome for small and medium-sized insurance undertakings. One of the tools to acheive 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 (Recital 19, Solvency II Directive)

8. The impact

9. Solvency II Specific treatment of captives Framework principles formally define a ‘captive’. Guidance from CEIOPS has further defined what will be treated as a captive: –‘The insurance obligations of an insurance captive undertaking only relate to contracts where all insured persons and beneficiaries in respect of unexpired risks are legal entities of the group of the captive undertaking and where all insured persons and beneficiaries were legal entities of the group at the time the contract was entered into. –The reinsurance obligations of a captive undertaking only relate to contracts where all insured persons and beneficiaries of the underlying direct insurance contracts in respect of unexpired risks are legal entities of the group of the captive undertaking and where all insured persons and beneficiaries of the underlying direct insurance contracts were legal entities of the group at the time the contract was entered into. –The insurance obligations of the direct insurance captive undertaking do not relate to any third party liability insurance.’ Opt out for captive owners if premium income below EUR5 million per annum –Unclear as to whether can ‘passport’ if opted out If not treated as a captive, subject to full effect of Solvency II

10. What does it mean if… You have a captive in the EU –Increased minimum regulatory capital –Increased operational procedures and accompanying documentation –Increased operational costs –Great disclosure of information into the public domain

11. Solvency II What might the market do? Exit some risk areas –Axa have already announced they are exiting some life business due to Solvency II Increase price on more volatile risks –Longer tail risks will require more capital to support than has previously been the case Increase fronting charges and collateral –Value of reinsurance provided by companies from non equivalent jurisdictions discounted within Directive Reduce ‘authority’ of underwriters –Potential for model to over ride decisions Market consolidation particularly amongst smaller companies

12. Solvency II & Captives Shelby Weldon Director, Insurance Licensing and Authorisation Bermuda Monetary Authority

13. Agenda Solvency II Regulatory Objectives Why seek equivalency Bermuda’s preparations and progress to date Captive implications

14. Regulatory Objectives Improve the risk management of EU insurers and reinsurers Advance supervisory convergence and co-operation Encourage cross-sectoral consistency – no regulatory arbitrage Introduce proportionate requirements for small undertakings Promote international convergence Increase transparency Ensure efficient supervision of insurance groups and financial conglomerates

15. Why Equivalency? OBJECTIVE: Compliance with International Standards Solvency II most imminent IMPORTANCE: Significant amount of business conducted between Bermuda and European markets BENEFITS: Bermuda (re)insurers can conduct business in Europe on a non-discriminatory basis Avoid duplicative regulatory oversight Gain access to markets more efficiently due to consistency of supervisory standards

16. Why Equivalency? OUR GOAL: Broad equivalency with Solvency II by 2012 OUR APPROACH: Pragmatic – not to duplicate requirements line-by- line Adopt intelligently in line with the nature of the Bermuda market

17. Solvency II Preparations & Progress Significant policy work and framework enhancements over the previous two years Bermuda Solvency Capital Requirement (“BSCR”) Internal Capital Model (‘ICM”) approvals Group-Wide Supervision framework Supervisory Colleges Insurance Code of Conduct

18. Solvency II Preparations & Progress Further enhancements in 2010: CISSA (Commercial Insurer Solvency Self Assessment) Eligible Capital Rules Public Disclosure Standards Enhanced Solvency Standards for Long-Term Insurers Building on supervisory Resources

19. Solvency II Preparations & Progress Bermuda’s framework enhancements are in accordance with the technical requirements of Solvency II as appropriate for the Bermuda market Changes focused on commercial sector of the market reinforcing the Authority’s risk-based approach to supervision

20. Implications for Captives Risk-based approach underpinned by the “Proportionality Principle” Article 29 of the Solvency II Directive states “Requirements are to be applied in a manner which is proportionate to the nature, scale and complexity of the risk inherent in the business of an insurer”

21. Implications for Captives Bermuda’s captive regime remains consistent with international standards Appropriate for the risk profile of companies in sector No significant changes at this time Actively monitoring and contributing to international developments

22. Solvency II & Captives Vlad Uhmylenko Director Standard and Poor’s

23. Systems of Governance (Pillar 2) Systems: Risk Management Compliance Internal Audit Actuarial Requirements: Proportionality –E.g. size, complexity “Fit and proper” BoD and mgmt Outsourcing –Properly vetted and monitored ORSA –Own Risk and Solvency Assessment Public Disclosure and Regulatory Reporting Requirements (Pillar 3 )

24. ORSA: Own Risk and Solvency Assessment An internal tool: –Requires (re)insurance enterprises to adequately assess their own short- and long-term risks –“Own funds” necessary to cover the identified risks and uncertainties Methodology used to determine solvency needs A tool for the supervisory authorities: –Enables the regulators to evaluate the insurer’s risk profile, risk management practices, and approach to capital management Proportionality: a lower bar for smaller/less complex insurers –Some outsourcing may be allowed –Further guidance needed on the minimum standards Requirement: Integrated Management of Risks and Capital

25. Integrated Management of Risks and Capital Risk Tolerance(s) Quantification and Aggregation Risk Limits (& other controls) Desired Risk Profile Risk-Vs.-Reward

26. Case Study: An S&P-Rated Captive Insurer Rating Criterion Enterprise Risk MgmtCapital Adequacy ObservationsP&C risks of the parent company; Avoidance of market and credit / counterparty risks Capital continues to increase (via retained earnings); No pressure to pay dividends ConclusionsAdequate risk culture and governance; as well as risk controls, risk analytics, and strategic risk management Redundant capital; Implicit support from the highly rated parent Integrated Management of Risks and Capital

27. Implications for Captives Pillar 1 may lead to greater capital requirements Pillars 2 and 3 may lead to a greater governance and management burden: –Higher expectations from the Board and the senior management –Formal and more sophisticated risk management As of now, few captives are ready for Solvency II Solvency II is likely to increase the cost of risks retained via captives Potential mitigants: –Principle of proportionality –Bermuda’s captive-specific solvency regime?

28. Questions