1. 1 Potential Rating Implications of Solvency II London 15 March, 2012 Catherine ThomasDirector, Analytics

2. 2  Key Issues: –Diversification benefits –Investment strategies –Available regulatory capital –Use of internal capital models

3. 3 Diversification benefits enhanced BEST’S PERSPECTIVE  Well diversified groups will be able to realise substantial reductions to their capital requirements  Larger groups more likely to seek internal model approval – potential for even greater diversification benefits  Internal models increasingly used to support strategic decisions  Diversification benefits from acquisitions that increase product offering or extend geographical reach RATING IMPLICATION  Diversification benefit applied consistently across the global insurance market through BCAR  Credit in BCAR for line of business diversification and economies of scale  Correlations increase during periods of extreme financial stress  Diversification for diversification’s sake viewed unfavourably  M&A - underwriting, execution and integration risk are key rating drivers

4. 4 Investment strategies BEST’S PERSPECTIVE  Individual asset classes will be examined to determine if returns support cost of capital  Equities, as well as longer dated and lower rated corporate bonds, are relatively capital intensive  EEA government bonds currently classified as risk free  Shift from long term to short term debt and towards higher rated corporate and government bonds  Alternative assets incur fixed 49% charge unless possible to “look through” to underlying assets RATING IMPLICATION  Continue to independently assess the risk profile of each rated insurer’s investment portfolio  Required capital to support investment risk calculated using BCAR  Capital charges based on risk of default, illiquidity and market-value declines  Do not differentiate between government and corporate bonds  Additional stress testing owing to European economic uncertainty

5. 5 Available regulatory capital BEST’S PERSPECTIVE  3 tiers based on 5 criteria: –subordination –loss absorption –permanence –perpetuity –interest deferral  Tier II and III capital will allow insurers to increase financial leverage RATING IMPLICATION  AM Best has its own methodology on equity credit for hybrid securities  Key characteristics – permanency of capital, ability to defer interest or dividend payments and subordination in an insurer’s capital structure  No change in methodology – allows for global consistency  Will monitor how companies respond to guidelines, in particular if this leads to further innovation in respect of hybrid instruments

6. 6 Credit for economic capital models BEST’S PERSPECTIVE  Customised model fit to company’s unique risk profile  Regulator reviews and approves the model  Development of an internal ECM generally viewed positively – company is exploring another way to quantify and manage its risk  Concerns regarding over-reliance RATING IMPLICATION  Difficult to compare company ECMs because of little standardisation  Insurers encouraged to share ECM output  Credit for ECM versus BCAR required capital  No change in methodology  Proven strong ERM + ECM capability = lowering of capital requirement over time

7. 7 Risk Management and BCAR – Best’s Approach LOWHIGH EXPOSURE TO EARNINGS and CAPITAL VOLATILITY BCAR BCAR Guideline Weak Risk Management Strong Risk Management Enhanced ERM

8. 8 Conclusion  Rating implications will depend on the final structure and calibration of Solvency II  Uncertainty remains –timing of implementation –transitional arrangements –final capital charges –equivalence –group supervision –internal capital model approval  Response of management will determine the impact on an insurer’s credit worthiness

9. 9 Catherine Thomas Director, Analytics A.M. Best Europe – Ratings Services Ltd catherine.thomas@ambest.com

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