Solvency Regulation in Iceland – Future Environment credit market securities market pension- market insurance market Willis Re’s Nordic Seminar 20th June 2007 Sigurður Freyr Jónatansson

2 Current status  The solvency position of the largest companies is strong in most cases  This also applies for the smaller life insurance companies  Most of the companies are not severly affected by FME’s stress test Likely reasons:  High return on investments in last years  Changed accounting methods  Solvency I regulation only takes underwriting risk into account

3 Recent developments (1)  Increased investment in equities  Reduced holdings in bonds  Reduced loans

4 Recent developments (2)  Increased activity abroad  Subsidiaries and participation  Norway  Sweden  Finland  Activity on the basis of freedom to provide services  UK  FME has increased cooperation with other supervisors

5 Effect of Solvency II - Overview  Pillar I  Capital requirements on market risk  Reduced holding in equities?  Reduced concentration  Pillar II  Coordinated supervisory methods  Pillar III  Coordinated supervisory and public reporting  Groups and cross sectoral (GCS) issues  Group risk and diversification benefits

6 Pillar I – Capital Adequacy

7 Hedgeable vs. non-hedgeable risks  Insurance risks are non-hedgeable  We can probably assume that pure financial risks can be hedged

8 Pillar I – Technical provisions  Will the best estimate be a challenge?  How to find the best estimate for annually renewable term life insurance contracts?  Opposite to QIS3 the probability of reinsurer default should be calculated (IASB compatible)  The risk margin will be calculated with the cost of capital method – future SCR will be estimated by proxies

9 Pillar I - Capital  The proposed changes will probably not have effect on the current situation  New methods to raise capital might be necessary if the solvency requirements increase  Subordinated loans  Preference shares  Other forms of hybrid capital

10 Pillar I – Operational risk  Not yet clear whether Pillar I or Pillar II are better suited to deal with this risk  Pillar I measurements could be supplemented with qualitative requirements  Companies would then benefit from good operational risk management

11 Pillar I – Market risk  1/200 year shock is 30-45% for equities  Therefore capital requirements for equities will always be high  Companies can reduce their risk by financial risk mitigating tools  Concentrations should be reduced  Spread risk measures the exposure changes in the credit spread/rating of counterparties

12 Pillar I – Counterparty default risk  No significant problems have emerged regarding reinsurers  Increased use of financial mitigating tools could lead to increased importance of this risk

13 Pillar I – Life underwriting risk  Calculations based on scenarios  Small companies might be allowed to use factor based proxies

14 Pillar I – Non-life underwriting risk  The size factor was abandoned in QIS3 – it’s future is to be decided  Should SCR for this risk cover expected losses/profits?  Catastrophe risk based on scenarios – how do we define catastrophes in the Icelandic market?

15 Pillar I – Safety measures  CEIOPS thinks that eligible assets must both be listed and meet given principles  The current list will probably not be amended  Current concentration limits regarding assets covering technical provisions will be dealt with by Pillar II

16 Pillar II – some issues recently discussed by CEIOPS  Treatment of “third country reinsurers”  IRCA and SRP – terms that companies must get used to  Internal Risk and Capital Assessment  Supervisory Review Process  FME’s guidance on stress test and risk management should prepare companies for this  Supervisory powers – probably insignificant change in Iceland  Limits on assets  Risks not covered by the standard formula  Prudent person plus principle

17 Some issues between now and Solvency II  The structure of the market and companies is getting more complex  The FME needs to have at any time the right information regarding the situation of companies  Solvency position  Risk management  Group structure – information on affiliated companies  Investments and asset allocation  Reinsurance and financial mitigation  Increased complexity means increased supervision and reporting requirements

For more information: credit market securities market pension- market insurance market