1. European & International Developments – implications for regulation in Ireland Michael Culligan Director, Life Strategies Ltd. “A new era for life assurance supervision” 4 March 2003 Michael Culligan Director, Life Strategies Ltd. “A new era for life assurance supervision” 4 March 2003

2. Outline of presentation n Examine international developments n Review main projects n Concentrate on two –EU and UK n Identify common themes n Likely impact

3. Current Irish regime (1) n Creature of EU Directives –First Directive in 1979 –Implemented in Ireland in mid 80s n Regime more or less unchanged since n External review by IMF in 2001 –Benchmarked Irish regime against IAIS “core principles”

4. Current Irish regime (2) n IMF findings: “Ireland observes the basic or necessary criteria…but may need to consider more stringent requirements to address the risks that could be inherent in a rapidly growing and increasingly complex sector” “Ireland is strong in areas affecting statutory technical reserves, solvency and asset management. Ireland’s system…focuses on solvency rather than market control”

5. Current Irish regime (3) n Probably fair characterisation by IMF –Strong on quantitative solvency supervision –Not so focused on other aspects n Reporting frequency “below best practice” n Limited resources for on-site inspections n Summary: “Ireland has been dependent on annual returns, the whistle-blowing responsibilities of the actuary and auditor, informal information flows and strong solvency to identify and contain risk”

6. Current Irish regime (4) n New guidelines from DETE in response –On-site visits –Strengthened Directors’ Cert. –Compliance Officers –Financial Condition Reports n Current system has worked well n But, now powerful forces for change –Advent of IFSRA –International developments

7. International developments (1) n Growing dissatisfaction amongst regulators n Shift in regulatory mindset –Recognition that quantitative measures not sufficient n Especially true in the EU… n … and in the UK n Others too –But will concentrate on these two

8. International developments (2) n Other projects include –International Association of Insurance Supervisors (IAIS) –International Actuarial Association (IAA) n Both will influence international standards n Also, others not directly related but very relevant –Basel Committee –International Accounting Standards Board (IASB)

9. EU developments (1) n “Solvency II” project n Aim is to review EU supervisory framework n Two phases –Phase 1: Deciding on broad principles –Phase 2: Fleshing out details n Phase 1 now drawing to close n Interim report issued

10. EU developments (2) n Work to date –Consultations within EU –External consultations with interested parties n Two key reports received for consideration –KPMG –Working group: lessons from the past

11. EU developments (3) n Preliminary ideas on shape of new system n Key principles have emerged –Basel approach to be adapted and adopted –Must take account of companies’ risks –Must be adaptable

12. EU developments (4) n What are the Basel proposals? –And how can they be adapted for insurance? n Basel has 3 strands (“pillars”) –Pillar 1: Quantitative requirements –Pillar 2: Supervisory review process –Pillar 3: Transparency/disclosure n Approach highlights defects of current system –Current system exclusively focused on Pillar 1

13. EU developments (5) n Basel Pillar 1 –Rules on technical provisions –Rules on investments –Rules on capital requirements n Concept of “target capital” –Likely to be determined by a risk model

14. The problem with modelling…

15. EU developments (5) n Basel Pillar 1 (contd.) –Rules on technical provisions –Rules on investments –Rules on capital requirements n Concept of “target capital” –Likely to be determined by a risk model –Breaches will result in dialogue with supervisor n Also lower “absolute minimum margin” –Easier to calculate –Breaches will result in intervention by supervisor

16. EU developments (6) n Basel Pillar 2 –Principles of “supervisory review process” n Principles (for banks) are: –Banks capital assessment procedures should be linked to risk profile –Supervisors must evaluate quality of those procedures –Supervisors need power to impose higher capital requirements –Supervisors must intervene at early stage

17. EU developments (7) n Basel Pillar 2 (contd.) –Principles need to be adapted for insurance –Pillar 2 lays down principles of sound organisation, internal control & risk management –Application of principles will be verified by supervisors n Supervision requires common approach across EU –Need common framework for corporate governance –Need harmonised early-warning systems –Need common validation of internal risk models etc.

18. EU developments (8) n Basel Pillar 3 –“Market discipline” –Essentially means disclosure and transparency n Published financial information –IASB already proposing much disclosure –Not sure that prudential system could/should add more n Disclosure to policyholders –Principle of “treating customers fairly” in Pillar 2 –Underpinned by disclosure rules in Pillar 3

19. EU developments (9) n Summary of EU developments –Solvency II now entering Phase 2 –Broad approach now largely agreed following Phase 1 –Consensus emerging that Basel banking approach be adapted for insurance –In other words, a “3 pillar” approach proposed –(Current approach purely focused on Pillar 1) –Likely implementation date – 2007 ?? –Transitional arrangements likely

20. UK developments (1) n Brisk pace of change! n Reasons? –Creation of FSA – single regulator –Equitable –Effect of current market conditions n Tiner project –“major overhaul” of insurance regulation –Progress report in Oct 2002 –Some changes already; many more over next 18 months

21. UK developments (2) n All change! “…fundamental change in the way that firms are regulated” “…more proactive and challenging regulatory relationship” “…risk based approach…” “…increased contact from supervisors…” “…explicit responsibility on senior management…” “…change…in what we expect from insurance firms…”

22. UK developments (3) n Three key prudential aims –Improve basis of determining capital/solvency requirements –Place more explicit responsibility on management –Improve public and regulatory reporting n Clearly similar to EU’s vision for Solvency II –3 pillar approach again n UK has shorter timescales though –“a lot done; more to do” –“we’re not there, but we’re getting there”

23. UK developments (4) n Aim #1: Improving determination of solvency –FSA clearly unhappy with current EU system “…the European Directives no longer adequately capture the risks to which insurance business is subject…” –Current approach to valuing assets & liabilities makes it difficult to assess firms’ realistic financial strength –FSA now adopting its own “more realistic approach” –Requires firms to apply for waivers –Plan to introduce fully in early 2004

24. UK developments (5) n Aim #1: Improving determination of solvency (contd.) n In practical terms, this means –Moving away from the net premium valuation –Greater use of stochastic modelling –Capital requirement = realistic liabilities + margin –Use stress-testing techniques to arrive at required margin

25. The difficulty with stress testing…

26. UK developments (6) n Aim #2: Sound management –Emphasis clearly on responsibilities of directors and senior managers n They need to be clearly able to: –Demonstrate understanding of responsibilities –Articulate how systems & controls work –Identify/rectify any weaknesses n Lots happening under this heading… –With-profits governance –Role of Appointed Actuary

27. UK developments (7) n Aim #3: Improving public and regulatory reporting –Number of improvements proposed –Less volume; more focused –More forward-looking –More distinction between public info and info given to FSA –Timeliness and frequency also under review

28. Summary and conclusions n Common themes are evident internationally –EU and UK in particular –Both unhappy with current system –Both moving towards Basel-style 3 pillar approach n Implications of new approach –Closer, more frequent contact with supervisor –Increased emphasis on risk –Increased use of models for determining capital –Improved public & regulatory reporting –In short, considerable change!

29. European & International Developments – implications for regulation in Ireland Michael Culligan Director, Life Strategies Ltd. “A new era for life assurance supervision” 4 March 2003 Michael Culligan Director, Life Strategies Ltd. “A new era for life assurance supervision” 4 March 2003