Implications of Solvency II Phil Ellis 10 Sept 2007

Context Amlin Lloyd’s and Bermuda based general insurer Marine around 15% to 20% of our account Phil Ellis, Group Actuary since 1999 Not an underwriter or a marine specialist (But not an accountant, either!) UK ICAS experience Similar in concept to Solvency II regime This talk is intended to develop key themes and skate over detail

Structure of today’s talk Reminder of the background Implications for balance sheets Company effects Capital calculation Internal effects Final thoughts

Background: The big questions Where?The European Union … but as a model for the world to follow What? Different view of Solvency (Balance Sheets) … but consistent with IFRS, so P&L too Why?Improve behaviour to reduce risk … aiming for a coherent risk framework How?A change to internal procedures & modelling … but with the fallback of a standard model When? 2012 (after latest deferral) … but impacts will be felt sooner Who?Accountants, actuaries, analysts … but everybody, including marine underwriters

Very Simple Balance Sheet A simplified balance sheet Capital is Assets less Liabilities Regulator specifies minimum capital required Assets 100 Liabilities 70 Capital 30

Simplistic Balance Sheet A simplified balance sheet If Min Capital is 20 Solvency ratio is 30 / 20 = 150% Solvency II changes each of: Assets Liabs Min Capital (SCR) Assets 100 Liabilities 70 Min Capital 20 Free 10

Basis of Solvency II Calcs Assets Market Values (or as close as possible) Liabilities Best Estimate Economic Values (≈ transfer cost) Discounted for Future Investment Return Loaded with a prescribed Risk Margin (cost of capital) Minimum Capital (Solvency Capital Requirement) 1 in 200 chance of insolvency over one year horizon Reflects actual risk profile for company (realistic values) Either from complex set of cross-EU standard factors Or from agreed internal model All more realistic than what we’re used to!

Balance Sheet Impacts - 1 Current Position (150%) Solv II – “Plausible” (143%) Assets 100 Liabilities 70 Min Capital 20 Free 10 Assets 110 Liabilities 60 SCR 35 Free 15

Balance Sheet Impacts - 2 Current Position (150%) Solv II – “Good” (233%) Assets 100 Liabilities 70 Min Capital 20 Free 10 Assets 120 Liabilities 50 SCR 30 Free 40

Balance Sheet Impacts - 3 Current Position (150%) Solv II – “Bad” (62%) Assets 100 Liabilities 70 Min Capital 20 Free 10 Assets 100 Liabilities 75 SCR 40 UNDER 15

Who are the Winners? Relative Solvency Position improves where: Asset Valuations currently well below market values Liability Valuations currently well above best estimates Reduction for discounting exceeds risk margin addition SCR increase is relatively small nature and scale of risks small and/or risk controls excellent Some impacts are “guessable” from outside a company Others may be very hard to spot in advance Large companies may well gain (recognition of diversity)

Company effects? Market positions altered Some companies may be too weak to carry on Others may be impaired and change operations “Big winners” may become more aggressive More M&A activity in next few years Various capital market solutions Rating agents not there yet, but pushing before 2012

Sensitivity of SCR to Rating SCR reflects all risks, valued at extreme probabilities(!) Time horizon is one year A key driver is prospective rating levels If rates have cycle ±20% around the mean Then SCR may vary by 2.5x over cycle Self-correcting mechanism Reduce volumes of risky and/or unprofitable lines at bottom (A key element of SCR is new business risk) But lines do not move perfectly in phase with each other Pressure within companies on poorest rated areas

Internal effects? (1) More actuaries, less barrow boys Pressure towards more modelling Price with explicit discounting, capital charge? Reserve at best estimates, discount & load? Detailed capital allocation(?!) Tails at extreme probability vital for capital Competition for capital within insurer Poor performance not tolerated?

Internal effects? (2) Senior management involvement Responsible for understanding Systems and data changes Embedding models for reduced capital? Detailed disclosures Risk management centre stage Procedures and documentation Different forms and/or levels of risk transfer?

Final thoughts Regulatory Plans & Procedures not final Big demands on insurers and regulators “Proportional” for smaller companies? Possible political compromises? Good to be ready for this early!

Any Questions? Cosimo Turi Phil Ellis