1.  Insurance related solvency regimes GIRO XXIX 2002 Convention Derek Newton 10 October 2002 Disneyland® Resort Paris

2. Insurance related solvency regimes nWhat is happening internationally? nWhat is likely to happen in the UK? nWhat is the role of the profession in all of this? nAre UK actuaries adequately equipped to meet the challenges of future solvency regimes?

3. What the UK actuarial profession is doing nGI Solvency Group nRole: nmonitor current developments nkeep GI Board/FIMC informed nrecommend response/action if appropriate nChairman: Derek Newton nCurrent Issues Committee nChairman: Derek Newton

4. The purpose of solvency capital nThe purpose of requiring insurers to hold solvency capital is to ensure that they have the financial capacity to meet their financial obligations to their clients nBut any minimum will not be sufficient

5. The role of the regulator in solvency regimes nIAIS: “..an insurance supervisor is expected primarily to protect policyholders and promote a secure and efficient market.” nFSA objectives nincrease public awareness npromote market confidence nprovide consumer protection nfight financial crime nSupervision does not detract from institutions’ responsibilities in any way - it merely provides a framework

6. The role of the regulator in solvency regimes nSo a solvency regime should instead aim to nreduce the likelihood of companies failing to meet their obligations nprovide a buffer against loss by their clients nprovide a trigger point at which the regulator gets involved nenhance public confidence nIt should be robust, workable, cost efficient and produce consistent results nIt cannot be considered in isolation. It is dependent on all aspects of the management of the regulated businesses

7. Basel agreement nThree “Pillar” approach nPillar 1: minimum requirements nPillar 2: self assessment of risks faced (guidance re considerations, operational risks, use of own internal capital models) nPillar 3: disclosure (link to IAS, to market disciplines, systems used, risk management procedures)

8. Lessons from banking nNot easy to draw as banking risks and insurance risks are quite different nHowever, it is clear that banks have majored upon analysing the risks that they already understand and have either not looked at or looked at in a simplistic way risks that they don’t yet understand nThe good news is that the new approach has forced the raising of risk management standards within the industry

9. Solvency I nFollowed Muller report (1997) nUpdates the existing regime (which dates back to 1973) nMinimum requirement up from €0.2-1.4m to €3m nPremium trigger for 16%/18% margin up from €10m to €50m nClaim trigger for 23%/26% margin up from €7m to €35m nAll indexed nAdditional 50% loading for volatile blocks of business (marine, aviation, general liability) nAdditional powers to regulators

10. Determinants of risk capital Insurance Portfolio Diversification Asset Portfolio Diversification Insurance Risk Investment Risk Reinsurance Economic Risk ALM ? and Solvency I Risk capital

11. Enter Solvency II nBlank piece of paper” n3 strands nlife nnon-life nwhat have been the common drivers or failures and of near failures

12. ..and what have been the common drivers of insurers failing or nearly failing? nPoor strategic investments nexpansion beyond experience/capability nAsset mismatching nInvestment policy following the needs of the owners rather than those of the business nManagement! npoor MI npoor skills set npoor decisions npoor control npoor self-awareness/lack of moral fibre(!)

13. What is likely to come out of Solvency II? n4 tier approach (Lamfalussy) nTier 1: Directives, incorporating overarching principles nTier 2: rules under EU law to be created by committee nTier 3: committee of regulators to harmonise actual practice between nations nTier 4: enforcement nBut as for the content there is still much uncertainty nMany interested parties (e.g. regulators such as FSA, IAA, Groupe Consultatif, AFIR, IASB, IAIS, IoA/FoA, ICAEW, ABI, etc.)

14. What is the UK position? nFSA is implementing a risk-based approach to regulation across all financial sectors nwhat are the risks to the regulated businesses nwhat are the risks to the FSA nFSA is seeking reassurance that management of each business nhas identified the risks that the business faces nunderstands those risks and their potential impact nis appropriately managing them

15. How will the FSA pursue a risk based approach? nCurrently uncertain - consultation paper imminent nHowever, it is clear that some form of scenario testing/RBC/DFA approach is envisaged, but nNo agreed system with EC of classifying risks, or even of defining them (e.g. IAIS 26 risk classifications, IAA multi-layer system nLots of work on the “easy” bits, e.g. underwriting risk. Very little on the hard to quantify stuff that really leads to problems. Seems to be an inclination to sweep this under the carpet nOperational risk is THE challenge nLimitations of models/limitations of model users - these things must be taken into account

16. And how would/will the FSA implement a risk based approach? nRoutine data or insurer/event specific data? Timing? nPublic or private? nconsumer needs nmarket needs nHow much should be prescribed? ndata nformat nmodels nManagement (identity, quality, philosophy, ability) nGuidance to best management practice? nRole of external advisors, etc.? nAdequacy of FSA resources/cost?

17. So where have we got to? nVested interests, e.g. national, professional, sacred cows nUK allied with Netherlands, Denmark, Sweden nUK usually opposed by Germany, France, Spain, Italy, Austria, Belgium, Luxembourg [Finland, Ireland, Portugal and Greece usually undecided] nSolvency II will run until at least the end of 2005 nActuaries need to be careful how they present themselves. Does our training and experience really make us ideally placed to pontificate on models and solvency levels? And if not then can we develop?

18. Possible approach Pillar III Market Discipline Disclosure recommendations and requirements create transparency by allowing market participants to assess key information on scope of application, capital, risk exposures, risk assessment and management processes, and capital adequacy of the insurance undertaking. Disclosures on: risks; key sensitivities and scenario analysis on assets and technical provisions. Pillar II Supervisory Review Assessment of the strength and effectiveness of risk management systems and internal controls. Review of: -exposures (including the reinsurance programme); -internal risk models; -stress testing of technical provisions and assets -systems and controls and approach to risk management -fitness and propriety of senior management - asset/liability mismatch. Pillar I Financial Resources Minimum capital requirements set for all firms using a risk based approach. Solvency margin requirement for individual undertakings by reference to assets and liabilities in the financial statements, plus risk charges. Group solvency requirements taking account of additional risks at group level.

19. Summary nLots going on in the world of regulation and solvency nMoving slowly but inexorably towards a risk based approach throughout Europe nMany practical issues to be addressed nMany technical challenges ahead for insurance professionals, including actuaries nStill time for everyone to influence the outcome