Title Slide JUN 8 – 10, Global Fronting

Renée M. Lewis Head of Global Trade and Receivables Finance HSBC Bank Bermuda Limited

EU’s Solvency II Directive will be in effect 1 January 2016 Introduction of a common European approach to regulation based on economic principles for the measurement of assets and liabilities. Although it is an EU regulatory framework, it will have direct and indirect implications to the U.S. insurance industry. Pillar 1 outlines quantitative requirements, which include –rules to value assets and liabilities (in particular, technical provisions), –Calculation of capital requirements and – the identification identify eligible own funds to cover those requirements. Global Fronting EU Lens and Solvency II

Pillar 2 –Outlines the requirements for risk management, and governance, –Details the supervisory process, –This will ensure that the regulatory framework is combined with each undertaking's own risk-management system and informs business decisions. Pillar 3 –addresses transparency, reporting to supervisory authorities and disclosure to the public and embedding market discipline. Global Fronting EU Lens and Solvency II

Capital requirements under Solvency II will be forward-looking and economic, i.e. they will be tailored to the specific risks borne by each insurer, allowing an optimal allocation of capital across the EU. They will be defined along a two-step ladder, including the solvency capital requirements (SCR) and the minimum capital requirements (MCR), in order to trigger proportionate and timely supervisory intervention. Global Fronting EU Lens and Solvency II

Portfolio Review and Decisions –Critical need for review by insurers to identify those classes and products that consume large amounts of risk capital which under the new regime will not in the long run be value add to the company e.g. non-life products with high exposure to catastrophe, with particularly volatile claims experience or with long run-off periods. Options will include discontinuance, amendments or specific restrictions embedded in products and or the creation of new ones for expansion and diversification of choice Global Fronting EU Lens

The higher demand for customized solutions will change the way cedants, reinsurers and brokers interact Collaborative cooperation of all stakeholders will be the driver in the delivery of new products to the market The new world of solutions will be designed to cover the 3 pillars of capital requirements, risk management and reporting Diversification and long term sustainable products will be critical for profitability and shareholder value As a result, standard reinsurance programs will make way for solutions finely tailored to risk profiles and balance sheets Global Fronting EU Lens

1 E.g. asset-gathering business.

A fronting insurer protects its own credit position by acceptable collateral such as letters of credit or trusts –Any risk written and ceded attracts capital –For a captive program, the risk is from the reserves: unearned premium reserves, outstanding loss reserves and incurred but not reported claims. –In calculating fronting fees, the fronting company must be certain to cover its own cost of capital and the residual credit risk after allowing for any qualifying collateral. –This is a key component of the fee especially as fronting companies have become more aware of the capital implications of ceding to unrated reinsurers. Global Fronting EU Lens :Collateral

Solvency II and the financial crisis have focused minds in the area of capital management. This may result in the fronting fees for certain accounts increasing to reflect the capital consumption Global Fronting EU Lens: Collateral

This example was based on a real case of a European primary insurer with approx. €1.5bn total investments. 2 Risk capital charge for equities (39% / 49% ± adjustment), real estate (25%), charge < 20% for investment grade corporate bonds with a duration < 10 years Global Fronting EU Lens: Collateral

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