Solvency II and the Swiss Solvency Test
János Blum
Casualty Loss Reserve Seminar San Diego, 11 September 2007
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Contents
Swiss Solvency Test
Industry Engagement -Test Runs
Swiss Solvency Test
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Swiss Solvency Test
Switzerland is not member of the European Union, but Swiss companies have pivotal interest in EU regulation
Compatibility to EU is a main objective of SST
Swiss Federal Office of Private Insurance designed, tested and partially implemented the new solvency system between 2002 and 2006
New Insurance Supervisory Law effective since 2006
Full implementation of SST beginning 2011
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Old Insurance Supervision
Rule based
Product and Tariff Approval
Restrictions on products, investments and pricing
No consideration of asset risks
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Old Insurance Supervision - Problems
Overexposure to risky assets
Underpriced long term guarantees
Accounting and regulatory arbitrage
Compliance culture
Abrogation of responsibility to the regulator
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New Insurance Supervision Act of 1.1.2006
No restrictions on products (except for some mandatory life and health products)
Less restrictions on investments
Corporate governance and risk management requirements
Appointed Actuary for all insurers and reinsurers
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New Insurance Supervision Act of 1.1.2006
Supervision of groups and conglomerates
Consistent requirements for insurers and reinsurers
Responsibility with senior management
Principle based
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The SST PrinciplesOutput – Methodology – Transparency - Responsibility
1. All assets and liabilities are valued market consistently
2. Risks considered are market, credit and insurance risks
3. Risk-bearing capital is defined as the difference of the market consistent value of assets less the market consistent value of liabilities, plus the market value margin
4. Target capital is defined as the sum of the Expected Shortfall of change of risk-bearing capital within one year at the 99% confidence level plus the market value margin
5. The market value margin is approximated by the cost of the present value of future required regulatory capital for the run-off of the portfolio of assets and liabilities
6. Under the SST, an insurer’s capital adequacy is defined if its target capital is less than its risk bearing capital
7. The scope of the SST is legal entity and group / conglomerate level domiciled in Switzerland
8. Scenarios defined by the regulator as well as company specific scenarios have to be evaluated and, if relevant, aggregated within the target capital calculation
9. All relevant probabilistic states have to be modeled probabilistically
10. Partial and full internal models can and should be used. If the SST standard model is not applicable, then a partial or full internal model has to be used
11. The internal model has to be integrated into the core processes within the company
12. SST Report to supervisor such that a knowledgeable 3rd party can understand the results
13. Public disclosure of methodology of internal model such that a knowledgeable 3rd party can get a reasonably good impression on methodology and design decisions
14. Senior Management is responsible for the adherence to principles
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Timetables
EU Switzerland
Political Decision 2002 2002
Project Start 2003 2003
Consulting Phase 2003 to 2009 2003 to 2005
Quantitative Impact Studies / Field Tests
2005 to 2008 (?) 2004 to 2007
New Legislation 2007 to 2011 2006
Mandatory Reporting 2012 2008
New Intervention Regime 2012 2011
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Some Differences SST – Solvency II
99% TVar vs. 99.5% Var confidence level
Cost of Capital approach for Market Value Margin– EU has not yet decided between i) 75th percentile and ii) Cost of
Capital approach
Minimum Capital Requirement 60% of Solvency Capital Requirement– EU has not yet decided between i) percentage of SCR and ii)
separate calculation for MCR, i.e. 90% confidence level
Operational Risk taken into account, but not part of Pillar I, as not sufficiently quantifiable
No restrictions on eligibility of capital – no tiers
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Cost of Capital Approach
SCR absorbs risks with 1 year time horizon
At the end of year 1, portfolio is assumed to be taken over by another company
New company provides regulatory capital to absorb run-off risk
Market Value Margin is the NPV of the future cost of capital at risk free rate + 6%
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Internal Models
If standard model not applicable, internal models mandatory– reinsurance, groups, entities with foreign branches– estimated 80 entities will have to develop internal models
Internal models encouraged, as they demonstrate high risk
management skills and provide relevant company specific information
High technical standards: stochastic modelling required. Building and validating internal models is resource intensive.
Consistency: same model should be used for all external reporting (regulator, rating agencies) and internal steering purposes
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Groups
Incentive to simplify complex group structures
SST required both on entity level and group level
Detailed internal model for groups
Diversification benefit on group level
Explicit modeling of Capital and Risk Transfer Instruments – internal reinsurance– loans– participations– guarantees– capital mobility
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Small Companies
Increased consolidation pressure
Complexity of Solvency II is a challenge for small entities:
– limited availability of resources and data
– low participation in test runs indicates lack of awareness
– loss mitigation relatively expensive
– standard model leads to high capital requirements, building more favourable internal models not viable
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Risk Management & Risk Mitigation
Risk Management will become key competence
– Data quality
– Capital adjusted pricing and product structuring
– Modelling capabilities
Demand for Risk Mitigation will increase
– Hedging financial risk for life insurers
– Reinsuring or securitizing cat risk for P&C insurers
Industry Engagement -Test Runs
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Quantitative Impact Studies
2005: QIS 1 – compared reserves under Solvency I and Solvency II– measured existing levels of prudence– tested Cost of Capital approach – increased awareness in the insurance industry
2006: QIS 2 – tested methods for calculating provisions, asset values, SCR and MCR– gathered information on practicability, data issues and resource
requirements – measured changes of overall level of solvency ratio
2007: QIS 3– calibrates risk and correlation matrices– tests impact on groups– tests internal vs standard models – results to be published in fall 2007
2008: possibly QIS 4 to back test draft directives
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Quantitative Impact Study 2
514 companies (out of 4‘000) from 23 countries participated– 237 P&C, 161 Life, 81 Composite, 22 Health, 13
Reinsurance
Overall market share 65% for Life, 56% for P&C – vary from 11% to 94% from country to country
Generally lower participation by small companies
Data quality inhomogeneous
Results published on a no name basis
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QIS 2 – Impact on Solvency
Assets valuated higher
Liabilities valuated lower
> Resulting Available Capital higher
Required Capital much higher
> Solvency Ratios decrease in general
Most Companies still with Solvency Ratios > 100%
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Swiss Field Tests
Facultative in 2004 and 2005 (before new legislation)
Mandatory for large companies in 2006 and 2007
46 (out of 150) entities participated in 2006, 29 of them on a voluntary basis. >90% market share covered.
Mandatory reporting for all companies starting 2008
Intervention based on new regime starting 2011, i.e. three year transition period
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SST - Solvency Ratios
Solvency Ratios lower, but mostly still sufficient (similar to QIS results)
Life: low correlation between old and new Solvency Ratios (R2 = 12%)
P&C: no correlation between old and new Solvency Ratios (R2 < 1%)
i.e. completely new situation for most companies
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SST - Breakdown of Balance SheetsApproximative Numbers
Life Health P&C
Reserves at Best Estimate
90% 50% 90%
Solvency Capital Required
8% 25% 7%
Market Value Margin 2% 0% 0%
Excess Capital 0% 25% 3%
Solvency Ratio 100% 200% 150%
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SST - Breakdown of SCR & MVMApproximative Numbers
Life Health P&C
Market Risk 70% 80% 30%
Credit Risk 5% 5% 10%
Insurance Risk 15% 25% 90%
Scenarios 10% 30% 0%
Diversification
(SCR reduction)
-20% -20% -25%
Expected Profit
(SCR reduction)
0% -20% -10%
Market Value Margin 20% 0% 5%
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SST – Historic Scenarios - LifeApproximative Numbers
Solvency drops from 100% to...
Market Crash 2000/2001 < 60%
European Currency Crisis 1992 70%
Market Crash 1987 75%
LTCM 1998 75%
Real Estate Crash 1994 80%
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Breakdown of Insurance Risk – P&CApproximative Numbers
Normal Claims 45%
Large Claims 15%
Reserves 40%
Diversification 0%
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Key findings
Life insurers sufficiently, P&C insurers well capitalized
Assets main risk for life insurers, balance sheets vulnerable to historic economic scenarios
Insurance (underwriting incl. cat) main risk for P&C insurers, balance sheets resistant to scenarios
Market Value Margin (reserve risk beyond 1 year) almost negligible for P&C insurers, more important for life companies