Non-Life Best Estimate 6 March 2017

Agenda 1.) Overview of Solvency II 2.) Focus on Assumptions 3.) Focus on Premium reserve 4.) Focus on Claim reserve

Overview of Solvency II 1

Objective of Solvency The Solvency is the capacity for an insurer to face its obligations towards beneficiaries of insurance contracts. The aim is the protection of the insured. The solvency requirements must be translated at 2 levels: An adequate level of technical provision in order to cover the business as usual. A minimum amount of capital in order to protect the viability of the insurer. Assets Liabilities Assets Capital Szolvencia célja: megfelelő tartalék állomány a jövőbeli kötelezettségek fedezésére Tőkemegfelelés biztosítása a biztosító működése céljából. Korábbi Szolvencia I és a mostani Szolvencia 2 összehasonlítása: Büntette a prudens biztosítót Most: kockázatalapú megközelítés Technical provisions 7 December 2016

Solvency II overview Solvency I framework Solvency I distinguishes between Life and Non-Life Insurers Required Capital depends on: Life Level of technical reserves, sum at risk, reinsurance cessions 4% of non-linked reserves and 1% of linked reserves and 0.1% to 0.3% of the sum at risk (including also 16-18% of rider premiums or 23-26% of claims incurred basis if higher for accident and health complementary to life contracts), reduced by the quota ceded to reinsurers (up to a maximum of 50%) Non Life Level of premiums, claims, reinsurance cessions Maximum between 16-18% of net written premium or 23-26% of incurred claims, reduced by the quota ceded to reinsurers (up to a maximum of 50%) Overview Solvency II

Solvency II overview Reasons to develop new Solvency supervision 1 2 3 Insufficient Risk sensitivity 1 Economic valuation framework vs. Accounting framework 2 Best Practice Risk measurement and management 3 European harmonisation 4 Measuring and managing more than the known risks 5 Credit crisis: more awareness and urgency 6 Overview Solvency II

Solvency II Balance Sheet Solvency II overview Solvency II – A dynamic model Fair Value Of assets Free Surplus Solvency Capital Requirement Min Capital Probability of default of 0,5% over 1 year period VaR al 99,5% Risk Margin Best estimate SCR Risk Margin Metodo del Costo del Capitale Best Estimate of technical provisions Solvency II Balance Sheet Overview Solvency II

Best Estimate Liability Focus on Technical provisions Best estimate Liabilities Solvency II Balance Sheet Assets Xs Own Funds Own Funds SCR MCR The best estimate shall correspond to the probability-weighted average of future cash-flows, taking account of the time value of money (expected present value of future cash-flows), using the relevant risk-free interest rate term structure. Risk Margin Best Estimate Liability Technical Provisions Overview Solvency II

Focus on Technical provisions Best estimate Liabilities The best estimate shall correspond to the probability-weighted average of future cash-flows, taking account of the time value of money (expected present value of future cash-flows), using the relevant risk-free interest rate term structure. Methodology Probability weighted average of future cash flows Using the relevant risk-free rate term structures Realistic assumptions Adequate actuarial and statistical methods Assumptions Consistent with information provided by financial markets Consistent with generally available data on insurance risks Policyholder behaviour Future management actions Overview Solvency II

Focus on Technical provisions Best estimate Liabilities The best estimate shall correspond to the probability-weighted average of future cash-flows, taking account of the time value of money (expected present value of future cash-flows), using the relevant risk-free interest rate term structure. Flows Non-life policies Inflow Future premiums Recoveries No investment return Outflow – claims Claims incurred Future claims (for future premiums) Outflow - expenses Administration expenses Claim handling expenses Acquisition costs Premium taxes Overview Solvency II

Focus on Technical provisions Best estimate Liabilities The best estimate shall correspond to the probability-weighted average of future cash-flows, taking account of the time value of money (expected present value of future cash-flows), using the relevant risk-free interest rate term structure. The premium and claim provisions are closely related in that they both represent a provision to cover the expected cash-flows, in and out, during the lifetime of the insurance and reinsurance obligations. The key distinsctions is that the claims provision covers claim events that have occured at or before the valuation date whilst the premium provision relates to cashflows to future exposure. Premium reserve: PV of future premium PV of future expenses PV of future claims (not yet occured) Claim reserve: PV of future payments for already occured claims Overview Solvency II

Focus on Assumptions 2

Focus on Assumptions Discount rate The risk-free rates shall meet all of the following criteria: they are free of any risk, undertakings are able to earn them in a risk-free manner in practice, they are reliably determined based on financial instruments traded in a market. Risk Free Interest rate The rates of the basic risk-free interest rate term structure shall meet the following criteria: insurance and reinsurance undertakings are able to earn the rates in a risk-free manner in practice; the rates are reliably determined based on financial instruments traded in a deep, liquid and transparent financial market. For each currency and maturity, the basic risk-free interest rates shall be derived on the basis of interest rate swap rates for interest rates of that currency, adjusted to take account of credit risk Published on a monthly basis by EIOPA https://eiopa.europa.eu/regulation-supervision/insurance/solvency-ii- technical-information/risk-free-interest-rate-term-structures Overview Solvency II

Focus on Assumptions Claim ratios are derived from the mixture of historical and expected datasets. Claim ratio Claim ratio = Claims incurred / Earned premium During the derivation costs may be included, but need to avoid double counting! The ratio may based on historical data or expert judgement if data is not available Due to the different charactheristics of the separate Line of Businesses, the claim ratio should be calculated for the separate LoBs. Overview Solvency II

Focus on Assumptions Operating assumptions are derived from the mixture of historical and expected datasets. Administration expenses The administration expenses are usually expressed as a percentage derived from the planned or historical expenses. If data is available the administration expenses may be calculated for the separate Line of Businesses. (LoBs) The administration expenses are covering the following expenses (the list is not complete): Overhead expenses Office rental Bills Other operating costs Administration expenses % = Administration expenses from the P&L / Earned premium Overview Solvency II

Focus on Assumptions Operating assumptions are derived from the mixture of historical and expected datasets. Lapse ratio Lapse assumptions are covering the possibility of future cancellation of the policies. If no historical dataset is available, the actuaries may consider an expert judgement or apply market benchmarks. Lapse rate = Cancelled premiums / Earned premium Overview Solvency II

Focus on Assumptions Operating assumptions are derived from the mixture of historical and expected datasets. Tax assumption For certain Line of businesses, the future premiums may have a taxable obligation. (insurance tax). May be expressed based on the expected payable tax of the forthcoming year or based on historical data Tax assumption % = Expected payable insurance tax / Earned premium Overview Solvency II

Focus on Premium reserve 3

Focus on Premium reserve Best estimate Liabilities Premium reserve is calculated to over future premiums for the existing business and future claim events Premium reserve The premium provision relates to cashflows of future exposure. Premium reserve covers the following: Future expenses Future claims Premium reserve = PV(cash-out flows - cash-in flows) It may happen that the premium reserve is negative! Premium reserve Expenses Future claims incurred Future premium Cash-in Cash-out Overview Solvency II

Focus on Premium reserve Example Premium reserve is calculated to over future premiums for the existing business and future claim events Premium reserve Let’s take a casco policy with Future written premium of 15 000 000 in the next year. The assumptions are the following: Lapse ratio: 5% Administration expenses: 6% Premium tax: 10% Expected loss ratio: 60% If the future premium is payable within 1 year, the time value of money may be ignored. Premium reserve Probability of premium payment: (1-5%) Expected cash-out: Admin: expected future premium * administration expenses Tax: expected future premium * tax rate Overview Solvency II

Focus on Premium reserve Example Premium reserve is calculated to over future premiums for the existing business and future claim events Premium reserve Now calculate the future claims for the future exposure! The expected loss ratio is 60% The claims are running of for a couple of years, therefore the time value of money should be taken into account How can we make a cash flow from the expected future losses? Estimate a run-off pattern for the claims (eg) Based on the experienced development factors Expert judgement Overview Solvency II

Focus on Premium reserve Best estimate Liabilities Discounting Premium reserve Let’s have the risk-free interest rates (RFR) the following: t_0=0.262% t_1=0,626% t_2=0,849% The discount factor for each t then is calculated as: (1+ 𝑅𝐹𝑅 𝑡 ) −𝑡 The PV then is calculated as: - 𝐸𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑝𝑟𝑒𝑚𝑖𝑢𝑚 −𝑒𝑥𝑝𝑒𝑛𝑠𝑒𝑠 −𝑐𝑙𝑎𝑖𝑚𝑠 ∗𝑑𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑓𝑎𝑐𝑡𝑜𝑟_𝑡 𝐸𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑝𝑟𝑒𝑚𝑖𝑢𝑚 −𝑒𝑥𝑝𝑒𝑛𝑠𝑒𝑠 −𝑐𝑙𝑎𝑖𝑚𝑠 ∗𝑑𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑓𝑎𝑐𝑡𝑜𝑟_𝑡 What does the result mean? Premium reserve: PV(Expenses) PV(expected claims) PV(future premiums) = Cash-in Cash-out Overview Solvency II

Focus on Claim reserve 4

Focus on Claims reserve Best estimate Liabilities The claim reserve is the coverage for claims that have already occured Claim reserve Recap from Solvency I Outstanding reserve (reported) IBNR (not yet reported) Calculated with usual actuarial techniques (eq Chain ladder) Cash-flow should be derived based on payment patterns Overview Solvency II

Focus on Premium reserve Best estimate Liabilities Run-off triangles Claim reserve The reserve can be calculated based on incurred or paid triangles or with other actuarial techniques Paid triangle: Estimates the OS and IBNR reserve together Incurred triangle: Need to adjust for the OS reserve May contain some prudency Overview Solvency II

Focus on Claims reserve Best estimate Liabilities Producing of the cash flows Claim reserve If the use an accident year / payment year triangle we need take into consideration the structure of the triangle: The blue diagonals are relating to the same payment years After the filling of the triangle, the payments should be calculated, rather than the cumulative payment up until the corresponding lag period Overview Solvency II

Focus on Claims reserve Best estimate Liabilities Producing of the cash flows Claim reserve The payments of the future years are in the blude diagonals > produce the payment pattern from them Overview Solvency II

Focus on Claims reserve Best estimate Liabilities Producing of the cash flows Claim reserve The last step is discounting back the future payment to the valuation date. Overview Solvency II

Focus on Claims reserve Best estimate Liabilities Producing of the cash flows Claim reserve The last step is discounting back the future payment to the valuation date. Overview Solvency II

Q&A Session

29 May 2018