1. Experience of the UK market in Social Security, Pensions and Insurance Regulation Dermot Grenham 25 November 2014

2. Agenda 1.The Government Actuary’s Department 2.UK environment 3.Social security 4.Pensions 5.Insurance Government Actuary’s Department www.gov.uk/gad Slide: 2

3. The Government Actuary’s Department > Provider of actuarial services to UK and non-UK governments, public sector pension schemes and social security schemes. > Around 150 staff including 70 qualified actuaries and 55 trainees. > Provides actuarial advisory services to a number of public sector organisations outside the UK directly or indirectly through work for the UK Department for International Development. > Website: www.gov.uk/gadwww.gov.uk/gad Slide: 3

4. The UK environment

6. Public sector Net Debt and Net Worth Government Actuary’s Department www.gov.uk/gad Slide: 6 Office of Budget Responsibility

7. G7 countries’ net debt Government Actuary’s Department www.gov.uk/gad Slide: 7 Office of Budget Responsibility

8. Employment rate projections Government Actuary’s Department www.gov.uk/gad Slide: 8

9. Social security

10. >Reforms to social security and welfare systems > State pension > Welfare benefits > Long term care Government Actuary’s Department www.gov.uk/gad Slide: 10

11. Government rational for reform >It pays to work; >The most vulnerable – disabled people and pensioners – are protected, and are supported to lead independent lives; >It pays to save for retirement, and the pensions system is clearer to understand; >Separating or separated parents are encouraged and supported to work together in the best interests of their children; and >Public spending is put on a more sustainable footing. Government Actuary’s Department www.gov.uk/gad Slide: 11

12. Government rational for reform In financial terms: >In the decade before the financial crisis, welfare spending rose by 20 per cent in real terms. >By 2010 welfare spending was costing every household in Britain an extra £3,000 a year. >Spending on Housing Benefit is up 50 per cent in real terms over the last decade. >The Office for Budget Responsibility’s projections suggest public expenditure on older people is set to rise by five per cent of GDP between 2016 and 2060. Government Actuary’s Department www.gov.uk/gad Slide: 12

13. Social security >State pension – drivers for change > Sustainability of the current scheme in the face of an ageing population and other fiscal challenges > Setting the new State Pension above the basic means test > Simplifying the system including removing derived rights and inheritance Government Actuary’s Department www.gov.uk/gad Slide: 13

14. State pension projections Government Actuary’s Department www.gov.uk/gad Slide: 14 Office of Budget Responsibility

15. Social security > Current system being replaced by ‘new State Pension’ from April 2016. > The new State Pension: >Flat rate (35 year contributions for a full pension, de minimis of 10 years to get anything) >No earnings-related element >No contracting out >Existing pensions in payment carry on as at present >Transitional arrangements for those that have accrued benefits under the current scheme > Mechanism for future reviews of State Pension age Government Actuary’s Department www.gov.uk/gad Slide: 15

16. Social security Government Actuary’s Department www.gov.uk/gad Slide: 16 Simplification A comparison of the current and new systems:

17. Social security >Welfare benefits > Universal credit >It is replacing six main benefits with a single monthly payment for people in work or out of work, smoothing the transition from welfare to work. >Unemployment benefits >Employment and support allowance >For ill and disabled >“Bedroom” tax Government Actuary’s Department www.gov.uk/gad Slide: 17

18. Social security Long term care >Sits on boundary between social security, health and local authority care responsibilities >Inconsistencies in current treatment >Individuals exposed to high lifetime costs >Now capped for care home fees >Scotland different to England Government Actuary’s Department www.gov.uk/gad Slide: 18

19. Pensions

20. Key changes – private sector >Reducing number of open Defined Benefit schemes >Defined contribution schemes increasing >Automatic enrolment >Pension freedom at retirement > Defined ambition Government Actuary’s Department www.gov.uk/gad Slide: 20

21. Pensions Key changes – public sector >Part of wider reform agenda “The reforms are part of wider changes which will deliver better value for the taxpayer, while keeping the pensions offered to public service workers among the very best available.” > Benefit reductions > Increased age at taking pension > Higher contributions > Cost cap Government Actuary’s Department www.gov.uk/gad Slide: 21

22. Insurance

23. Insurance Industry Regulation The Prudential Regulatory AuthorityThe Prudential Regulatory Authority (PRA) regulates key aspects of the financial strength of a firm The Financial Conduct AuthorityThe Financial Conduct Authority (FCA) regulates how firms behave Currently subject to Solvency I and Individual Capital Adequacy Standards (ICAS) framework More on this later… Government Actuary’s Department www.gov.uk/gad Slide: 23

24. Insurance Industry Insurance and UK Government HMT The UK insurance growth action plan, 4 December 2013 “The insurance sector makes a vital contribution to the UK economy, employing over 300,000 people across the country, attracting global capital, serving the needs of consumers, and generating UK exports. It plays a fundamental role in assessing and managing risk – whether strengthening the resilience of local communities, sustaining regional growth, or underpinning global trade. We are therefore committed to making the UK one of the most competitive places in the world for insurance.” Government Actuary’s Department www.gov.uk/gad Slide: 24

25. Current Regime Good regulatory legislation promotes efficient, fair, safe and stable insurance markets for the benefit and protection of policyholders >Promote growth and competition >Enhance efficiency >Reduce transaction costs >Create liquidity >Facilitate economies of scale >Allocate resources >Manage risk >Mobilise long –term savings Government Actuary’s Department www.gov.uk/gad Slide: 25

26. Current Regime Current EU solvency regime > Life insurance >Prudent actuarial valuation >Assumptions include margins for adverse deviation > General insurance >Accounts value >UPR + URR + OSC (including IBNR) >Usually not discounted Government Actuary’s Department www.gov.uk/gad Slide: 26

27. Current Regime Current EU solvency regime > Eligible capital >assets less liabilities >less intangible assets >plus (subject to restrictions) >unpaid share capital >hybrid share capital >subordinated loans Government Actuary’s Department www.gov.uk/gad Slide: 27

28. Current Regime Current EU solvency regime > Solvency capital requirement >Simple formula-based approach >‘One size fits all’ Government Actuary’s Department www.gov.uk/gad Slide: 28

29. Current Regime Accounting standards No single global accounting standard or insurance UK requirements different depending on listing of company >IFRS 4 >UK GAAP >ABI SORP >US GAAP Government Actuary’s Department www.gov.uk/gad Slide: 29

30. Current Regime Why the need for change? > Different standards across the EU > Valuation of assets and liabilities not market-consistent > Unspecified levels of prudence in technical provisions > Arbitrary restrictions on investment > Solvency capital does not reflect actual risks of insurer Government Actuary’s Department www.gov.uk/gad Slide: 30

31. Insurance Regulation– Upcoming Changes

32. Upcoming Changes Solvency II objectives (1) > Harmonise standards across EU > Compatible with IASB and banks (where possible) > Market-consistent valuation of assets and liabilities > Assess overall solvency using a prospective and risk-based approach, reflecting actual risks of insurer > Provide incentive to insurers to properly identify, measure and manage their risks > Improve supervision of insurance groups Government Actuary’s Department www.gov.uk/gad Slide: 32

33. Upcoming Changes Solvency II objectives (2) > Overall aim to: > Protect policyholders and beneficiaries > Improve competitiveness of EU insurers > Provide for a better allocation of capital resources Government Actuary’s Department www.gov.uk/gad Slide: 33

34. Upcoming Changes Three pillar approach > Pillar 1 – quantitative requirements > detailed technical rules for valuation of assets and liabilities, eligible capital and required solvency capital > Pillar 2 – qualitative requirements > insurer’s own risk management and internal control processes, supervisory review process and other supervisory powers > Pillar 3 – disclosure requirements > public disclosure and private reporting to supervisor Government Actuary’s Department www.gov.uk/gad Slide: 34

35. Upcoming Changes Solvency II project – timetable to implementation (a) (as at March 2014) > Framework Directive (Nov 2009) > Omnibus II Directive agreed (Mar 2014) > EIOPA consults on 1 st set of L2 technical standards and L3 guidelines (Q2 2014) > EC publishes L2 delegated acts (Q3 2014) > EIOPA submits 1 st set of L2 tech stds to EC, and consults on 2 nd set of L2 tech stds and L3 guidelines (Q4 2014) Government Actuary’s Department www.gov.uk/gad Slide: 35

36. Upcoming Changes Solvency II project – timetable to implementation (b) (as at March 2014) > L2 delegated acts agreed (Q1 2015) > EIOPA publishes 1 st set of L3 guidelines (Q1 2015) > Member States transpose SII into domestic law (31/03/15) > EIOPA submits 2 nd set of L2 tech stds to EC (Q2 2015) > EIOPA publishes 2 nd set of L3 guidelines (Q3 2015) > Solvency II comes into force (01/01/16) Government Actuary’s Department www.gov.uk/gad Slide: 36

37. Upcoming Changes Main elements of pillar 1 (quantitative requirements) > Valuation of technical provisions >‘market-consistent’ rather than ‘prudent’ > Asset rules >principles-based rather than prescriptive > Eligible capital >more detailed rules specifying assets into tiers according to availability for use > Solvency capital requirements >reflects insurer’s actual risk profile >based on defined Value-at-Risk measure Government Actuary’s Department www.gov.uk/gad Slide: 37

38. Upcoming Changes SCR – general requirements > Calculated on a going concern basis > Take account of all quantifiable risks > Include new business over the next 12 months > Corresponds to Value-at-Risk of basic own funds at 99.5% confidence level over one year period Government Actuary’s Department www.gov.uk/gad Slide: 38

39. Upcoming Changes SCR – standard formula Government Actuary’s Department www.gov.uk/gad Slide: 39

40. Upcoming Changes SCR – internal models > May be full or partial model > Model must be approved by supervisor > Partial model must be consistent with standard formula > … and limited scope must be justified > Supervisor must approve policy for changes to model >Small changes in line with policy do not need prior approval >Major changes (and changes to policy) always need approval >Cannot revert to standard formula without approval Government Actuary’s Department www.gov.uk/gad Slide: 40

41. Upcoming Changes SCR – internal models Model must meet a series of tests, to gain approval > Use test > Statistical quality standards > Calibration standards > Profit and loss attribution > Validation standards > Documentation standards Government Actuary’s Department www.gov.uk/gad Slide: 41

42. Upcoming Changes MCR – general requirements (1) > Simple auditable calculation > Corresponds to ‘unacceptable’ level of risk > Calibrated to Value-at-Risk of basic own funds at 85% confidence level over one year period > Absolute floor varies by: >Business: life/non-life >Classes of business >Company type: insurer/reinsurer/captive Government Actuary’s Department www.gov.uk/gad Slide: 42

43. Upcoming Changes MCR – general requirements (2) >Linear calculation based on >Technical provisions >Written premiums >Capital-at-risk >Deferred tax >Administrative expenses >Minimum 25% of SCR, maximum 45% of SCR >Calculate at least quarterly Government Actuary’s Department www.gov.uk/gad Slide: 43

44. Upcoming Changes Main features of pillar 2 (qualitative requirements) > Requirements for both insurers and supervisors > New emphasis on risk management/internal controls > EC aims to increase harmonisation of supervisory standards, processes and powers Government Actuary’s Department www.gov.uk/gad Slide: 44

45. Upcoming Changes Key elements of pillar 2 > Governance, risk management and internal controls > Own risk and solvency assessment (ORSA) > Supervisory review process (SRP) > Capital add-ons > Supervisory intervention and other powers Government Actuary’s Department www.gov.uk/gad Slide: 45

46. Upcoming Changes Supervisory review process (1) > Main supervisory objective – to protect policyholders > Supervision must: >be prospective and risk-oriented >cover both qualitative and quantitative elements >include both on-site and off-site supervision >be proportionate to risks >be transparent and accountable Government Actuary’s Department www.gov.uk/gad Slide: 46

47. Upcoming Changes Supervisory review process (2) > Supervisor to review and evaluate compliance with: >Governance, risk management systems >Own risk and solvency assessment >Technical provisions >Capital requirements >Investment rules >Quality and quantity of own funds >Use of internal model Government Actuary’s Department www.gov.uk/gad Slide: 47

48. Upcoming Changes Supervisory review process (3) > Forward-looking: assess ability of the company to identify, evaluate and withstand future adverse changes > Key element is insurer’s ORSA (and the extent to which it identifies risks not covered in SCR) > Supervisor sets frequency and scope of review based on risk profile of insurer > Overall purpose of SRP is to identify any material deficiencies in risk assessment, management processes or capital adequacy and determine appropriate action Government Actuary’s Department www.gov.uk/gad Slide: 48

49. Upcoming Changes Supervisory intervention (1) > EC aim to bring supervisory powers up to a common standard across Member States > Greater convergence to avoid ‘regulatory arbitrage’ > Supervisory intervention should be proportionate reflecting risk to policyholders (‘ladder of intervention’) Government Actuary’s Department www.gov.uk/gad Slide: 49

50. Upcoming Changes Supervisory intervention (2) > Failure to comply with SCR > insurer to submit ‘realistic recovery plan’ within 2 months > ensure compliance within 6 or 9 months > Failure to comply with MCR > insurer to submit ‘short term finance scheme’ within 1 month > ensure compliance within 3 months > supervisor may restrict free disposal of assets > ultimately may withdraw authorisation leading to winding-up Government Actuary’s Department www.gov.uk/gad Slide: 50

51. Upcoming Changes Key elements of pillar 3 > Public disclosure > Solvency and Financial Condition Report – required annually > Supervisory reporting > Includes all information required to be submitted to the supervisor, on a regular basis or in response to a defined event > Not intended to be publicly available Government Actuary’s Department www.gov.uk/gad Slide: 51

52. Upcoming Changes Public disclosure > Solvency and Financial Condition Report includes: > description of insurer’s business and performance > description of system of governance and assessment of adequacy for risk profile of insurer > for each category of risk, description of risk exposure, risk concentration, risk mitigation and risk sensitivity > methods and assumptions used to value assets, technical provisions and other liabilities > extensive disclosure of insurer’s capital management Government Actuary’s Department www.gov.uk/gad Slide: 52

53. Upcoming Changes Supervisory reporting > Draft directive includes general principles only > Insurers must submit all information ‘necessary for the purposes of supervision’ > Supervisor determines the nature, scope, format and timing of reporting, but … > … detailed Level 3 guidance has been issued (in draft) including extensive annual and quarterly templates Government Actuary’s Department www.gov.uk/gad Slide: 53

54. Upcoming Changes Accounting standards - Changes > IASB undertaking comprehensive project on accounting for insurance contracts 2007 - ?? > IFRS 4 Update expected in 2015 with compliance by 2018 > Significant revision following 2010 paper > As of March 2014 likely to be more aligned to US GAAP with an Accounting Standards Update Government Actuary’s Department www.gov.uk/gad Slide: 54

55. Upcoming Changes Accounting standards – Challenge to Insurers > Data processes > Systems > Staff > Education of stakeholders All while implementing Solvency II Government Actuary’s Department www.gov.uk/gad Slide: 55

56. Questions?