Head of Unit, Insurance and Pensions, DG Markt, European Commission Faculty of Actuaries Edinburgh, 1 October 2007 The Challenge of Solvency II Karel VAN HULLE Head of Unit, Insurance and Pensions, DG Markt, European Commission

« Not everything what can be counted counts – and not everything what counts can be counted » Albert Einstein

Proposal for a Framework Directive July 10th 2007 14 existing Insurance Directives (direct insurance, reinsurance, groups etc.) + Solvency II Codification & New Articles Recast & Codification = 1 Directive ‘EU Insurance sourcebook’

Solvency II – 4 Principal Objectives Deepen the Single Market Enhance policyholder protection Improve (international) competitiveness of EU insurers Further Better Regulation

The new regime… Introduces an economic risk based approach that will reward good risk management and enhance policyholder protection Places emphasis on the responsibility of the senior management to manage their business responsibly Fosters and demands greater supervisory convergence across the Community

Legislative Process - Lamfalussy Level 1: Framework Directive Level 2: Implementing Measures Level 3: Convergent implementation assisted by close co-operation between national authorities Level 4: Rigorous enforcement of Community legislation by the Commission

Many players & stakeholders in the process… Commission Proposal for a Directive following consultation & dialogue with Industry Professionals (e.g. Groupe Consultatif) CEIOPS Member State Experts European Parliament and Council of Ministers negotiate and have final say over law Implementation by national authorities and 1000s of insurers in Europe

Quantitative Impact Studies Key element of Better Regulation QIS 3 April – June 2007 Analysis and conclusions from QIS3 will be published in November 2007 Results will feed into negotiations, changes to high-level framework if necessary QIS 4 will take place between April and July 2008 following public consultation with all stakeholders Results of QIS4 will feed into development of implementing measures

Solvency II timetable for 2007-2012 2008 2009 2010 2011 2012 2006 Directive development (Commission) Directive adoption (Council & Parliament) Implementation (Member states) CEIOPS work on technical advice necessary for implementing measures / supervisory convergence / preparation for implementation / training & development Commission preparatory work on possible implementing measures and impact assessment Adoption of Implementing measures July 2007 Solvency II Directive published 2012 Solvency II enters into force QIS 2 QIS 3 QIS 4

Solvency II – Content & Targets Solvency II uses the “three-pillar approach” found in Basel II Underwriting Risk Market-/ALM Risk Credit Risk Operational Risk Risk category Solvency requirements Pillar I Quantitative Supervisory Calculation of a risk adequate capital need on the basis of company individual risk profiles Incentives to develop internal systems to measure and manage risks Cover- und Capital investment directives Integrated Solo-Plus supervision and Supervision of reinsurance companies Supervisory process Pillar II Qualitative Supervisory Assessment of the Risk management and control systems and processes Supervisory of: Risk categories RI Program Internal Risk Model Stress tests and sensitivities Asset-Liability Mismatch Mgmt. assessment „Fit and Proper“ Peer Reviews of other Supervisory Bodies Market transparency Pillar III Strengthening of Market mechanism Disclosure requirements Risks Sensitivity and scenario analysis of assets and technical provisions Results of the quantitative and qualitative supervisory Assessment ….. Still widely undefined, ongoing dialog with the IASB Trend: Fair Value Reporting

From Solvency I to a Solvency II Balance Sheet Economic View “The overall objective of prudential regulation must be to ensure that an insurer maintains, at all times, financial resources which are adequate, both as to amount and quality, to ensure there is no significant risk that its liabilities cannot be met as they fall due.” (CP20, 2.2) „OLD“ „NEW“ Statuary Value of Assets Statuary Value of Liabilities. Required Capital Ratio of required to available capital Market Value of Assets Best Estimate of Liabilities. Risk- Margin Technical Provisions Solvency Capital Requirement Ratio of required to available capital Available Capital Minimum Capital Requirement

Solvency II – Challenges

Pillar I The introduction of market consistent valuation of assets and liabilities and economically based capital requirements will require insurers: to accurately assess their current financial position using modern financial mathematical and actuarial techniques and to better manage their asset-liability mis-match risk to fully understand the economic effects of the risk mitigation techniques they use such as reinsurance, securitisation and derivatives

Pillar II The introduction of qualitative risk management standards covering all risks, not just those captured by the Pillar 1 requirements will require insurers: to ensure that risk assessment and risk management play a central role in their system of governance to explain to their supervisors how they manage and control the risks they run and how they determine their own capital needs

Actuarial Function The acturial function shall be carried out by persons sufficient knowledge of actuarial and financial mathematics and able where appropriate, to demonstrate their relevant experience and expertise with applicable professional and other standards

Coordinate the calculation of technical provisions; Ensure the appropriateness of the methodologies and underlying models used as well as the assumptions made in the calculation of technical provisions; Assess the sufficiency and quality of the data used in the calculation of technical provisions; Compare best estimates against experience; Inform the administrative or management body of the reliability and adequacy of the calculation of technical provisions; Oversee the calculation of technical provisions; Express an opinion on the overall underwriting policy; Express an opinion on the adequacy of reinsurance arrangements; Contribute to the effective implementation of the risk management system.

Pillar III The introduction of new disclosure requirements bringing market discipline to bear on insurers will require insurers: to explain to shareholders, rating agencies and analysts clearly and accurately how their risk profile and risk appetite fits in with their overall business strategy to explain to external stakeholders how they assess and manage risk, particularly those insurers using an internal model to calculate capital requirements

Group supervision Insurers wishing to use the new approach to group supervision will be required: to monitor, manage and control risk at group level, and in particular diversification effects across both legal entities and lines of business in their risk management processes and practices to manage their capital needs and investments holistically rather than in a piece-meal fashion on a legal entity basis

Conclusion Solvency II is all about improving risk management and rewarding already existing good practice Updating risk management processes and practices in any company takes time Insurers need to start preparing now, if they do not want to be caught out when Solvency II comes into force The future belongs to those who prepare for it today