1. © 2002 KPMG NINTH ANNUAL CONFERENCE OF INTERNATIONAL ASSOCIATION OF INSURANCE SUPERVISORS 11 October 2002 FINANCIAL SERVICES

2. © 2002 KPMG Joachim Kölschbach The case for change 1

3. © 2002 KPMG The case for change Why change ? The role of capital What are the alternatives ? 2

4. © 2002 KPMG The case for change - Europe The European solvency system has worked well -Prudent asset and liability valuation rules have offered a cushion to absorb unexpected losses But there are inconsistencies in implementation of directives -Super-equivalent rules -Inconsistent accounting rules -Implicit capital requirements Change in business and market dynamics (lower interest rates, equity returns, guarantees, operational risks) Future accounting developments All highlighting the pressing need for reform 3

5. © 2002 KPMG The case for change - International Need for level playing field globally and across the financial sector Capital markets pressure to optimize use of capital US terrorist attacks have created solvency concerns for a number of insurers Developments in the banking industry Other regulatory authorities move towards more advanced approaches 4

6. © 2002 KPMG Business case for change... but computer power now exists to develop complex and better models Manage risks and capital effectively Transparency Rating agency pressure Understanding risks and risk interaction Competitive pressure 5

7. © 2002 KPMG The role of capital Provides buffer against -Risks -Expected and unexpected future losses -Deterioration in provisions Capital definition – how much capital is required? Regulatory capital vs risk capital – should there be a difference? Relationship between provisions, assets and reserves – does it matter? Source: KPMG, Study for the European Commission, May 2002 6

8. © 2002 KPMG Overview: Assets and liabilities in the solvency system Liabilities Investments Reinsurers’ share of technical provisions Other assets Actual margin of solvency Relationship with liabilities Prudent valuation methods Market risk Credit risk Operational risk Asset / liability mismatch risk Insurance risk Required margin of solvency 7

9. © 2002 KPMG What are the alternatives ? Benefits in simplicity of European fixed ratio approach The US RBC approach aims to incorporate more risks Canadian & Australian supervisors are encouraging the development of internal risk models Apparent benefits in more sophisticated approaches may be undermined by practicalities of implementation Fixed ratio Risk based capital More advanced approaches Source: KPMG, Study for the European Commission, May 2002 8

10. © 2002 KPMG EU fixed ratio approach AdvantagesDisadvantages SimpleNo clear capital definition Little subjectivityInadequate recognition of risks No significant data issuesWeak predictive power Low compliance cost Inconsistent valuation of assets and liabilities Easy to standardiseLittle effect on internal risk management Source: KPMG, Study for the European Commission, May 2002 “…to calculate a solvency margin requirement based on fixed proportion of a proxy for exposure to risk.” 9

11. © 2002 KPMG Risk based capital approaches AdvantagesDisadvantages Relatively simpleNo clear capital definition Little subjectivity Not enough scope for risk-interaction, diversification and size effects No significant data issues Operational and reinsurance risks not adequately dealt with Low compliance costNot dynamic Easy to standardiseLittle effect on internal risk management Source: KPMG, Study for the European Commission, May 2002 “…to calculate capital requirements which reflect the size and overall risk exposures of an insurer” 10

12. © 2002 KPMG Fixed Ratio RBCScenario based Probabilistic approach Extent of risksPoorGood Excellent Risk interactionPoorFairGoodExcellent Predictive powerPoorFairGoodExcellent DynamicPoorFairGoodExcellent DataMinimalModerateConsiderableDemanding SubjectivityNone Considerable CostLow MediumHigh StandardisationEasy PossibleDifficult Assessment of different approaches Source: KPMG, Study for the European Commission, May 2002 11

13. © 2002 KPMG Key challenges for a future system Greater recognition of risks Company specific risk profiles Size and diversification effects Broad risk categorization Operational and asset/liability mismatch risk Explicit and transparent system 12

14. © 2002 KPMG Overview of KPMG study Chapters -Risks & risk models -Technical liabilities -Asset valuation -Reinsurance -Alternative risk transfer arrangements and advanced risk reduction techniques -Impact of future accounting changes -Use of rating agencies and market mechanisms -Comparative analysis of solvency margin methodologies 13

15. Conclusion Use of risk models Enhanced risk management Need for flexibility in supervisory approach Broad workable framework Risk based Cost effective Banking regulatory developments Accounting changes Consistency and transparency of capital requirements Greater recognition of risks © 2002 KPMG LLP. KPMG LLP, a UK limited liability partnership and the UK member firm of KPMG International, a Swiss nonoperating association. All rights reserved. Printed in Belgium. 14

16. © 2002 KPMG NINTH ANNUAL CONFERENCE OF INTERNATIONAL ASSOCIATION OF INSURANCE SUPERVISORS 11 October 2002 FINANCIAL SERVICES