Solvency II and return

on equity; optimizing

capital and manage

the riskMaria Haug Edvardsen

GRC 2016, May 19

Content

• Solvency II introduction

• return on equity

• risk appetite and risk

tolerance

• framework on risk

management

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Solvency II - the basics

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Solvency II

Purpose:

• to reduce the risk that an insurer would be unable to meet

claims;

• to reduce the losses suffered by policyholders in the event that a

firm is unable to meet all claims fully;

• to provide early warning to supervisors so that they can

intervene promptly if capital falls below the required level; and

• to promote confidence in the financial stability of the insurance

sector.

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Solvency II

Pillar I

quantitative

capital

requirements

Pillar II

qualitative

requirements

Pillar III

reporting and

disclosing

«To have enough

resources when

something bad

happens»

«To prevent

something bad to

happen»

«To say what I

have, what I need

and what I do»

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Solvency II – pillar I

Assets at

market

value

Solvens Capital Requirement (SCR)

Technical Provisions

Best estimate

Risk margin for non-hedgeable risks

Assets covering technical

provisions, MCR and SCR

Minimum Capital Requirement (MCR)

BufferNew Solvency II

balance

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Pillar II

• governance

• fit and proper

• risk management

• ORSA

• internal controls

• internal audit

• actuarial function

• outsourcing

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Pillar III

Disclosure and transparency:

• SFCR (solvency and financial

condition report)

• RSR (regular supervisor report)

• QRT’s (quantitative reporting

templates)

• ORSA (own risk and Solvency

assessment)

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Return on equity

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Return on equity

• Traditional financial theory assumes that the higher the risk you

are willing to take, the higher the potential return (and potential

losses) can be expected.

• Running a company involves in itself a certain risk.

• A company must take risks to achieve a return on capital.

• Return on equity (ROE) measures the return on the capital that

the owners have put into the company, and can show how

profitable a company is for its shareholders.

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Return on equity

• The new risk-based Solvency II regime requires companies to, at

a much greater extent than previously, link the company's capital

to the actual risk they face at a selected strategy.

• The capital base consists of: risk capital and buffer capital.

• Risk capital is the amount of capital to cover the risks the

company faces. Other capital will be considered as buffer capital.

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Risk appetite and risk tolerance

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Risk appetite

• One of the boards’ responsibility

is to define a clear strategy for

the company and a risk appetite

• How to establish a proper risk

appetite?

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Risk appetite and risk tolerance

Risk universe

Risk capacity

Risk tolerance

Risk appetite

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Risk Appetite

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Risk too low

Risk Appetite

Risk too high

Target

Limit

Tolerance

Risk Capacity

Risk appetite – how to define it?

Source: Institute of International Finance: ”Implementing robust risk appetite frameworks

to strengthen financial institutions”, 2011

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Risk appetite - input

Strategy and risk

• rating

• growth

• efficiency

• solvency ratio target, minimum ratio target

• results

• RoE

• growth

• VaR Limits

• minimum level for business continuity

• etcetera

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Examples

high growth ambitions

high risk appetite

high risk tolerance

high targets on rate of return

low risk appetite

high risk tolerance

How much capital do a company need in order to reach its

strategic targets?

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Risk Capital

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Risk capital and

buffer capital

• How to decide the right amount

of risk capital (the right risk) and

an adequate capital buffer? (Too

much capital buffers could

impose excessive costs on both

the costumers and the sector).

• The boards responsibility:

strategy, risk appetite.

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Return on equity and buffer capital

Assets at

market

value

Solvency Capital Requirement (SCR)

Technical Provisions

Best estimate

Risk margin for non-hedgeable risks

Assets covering technical

provisions, MCR and SCR

Minimum Capital Requirement (MCR)

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Optimize the capital

MCR

SCR

ORSA

Pilar I Pilar II

SCR

internal

model

add-on

from

FSA

add-on to

please

rating

agents,

etcetera

actual

capital

?

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Solvencymargin (%) = Available capital/SCR

Minimum 100 %

Risk capital

ZoneSolvencymargin

(examples)

red < 120%

yellow 120-160%

green 160-200%

yellow >200%

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Distribution of risk capital

45

30

1015Example:

Risk appetite pr.

category or

products

Goal:

to optimize the

allocation of

capital

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Risk management

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Riskunivers & risk capital

Strategic

risks

Insurance

risks

Financial

risks

Operational

risksOther risks

Aggregated

riskRisk capital

Policies and mandates

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Risk management framework

Risk appetite and risk tolerance

Governance, organization and people

Strategy and policyInternal controls and assurance

Risk identification, transfer, mitigation and reporting

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Risk function

• aggregated view on risk (today and forward)

• integrated part of the business processes

• ORSA

• risk reporting

• fit and proper

• capacity

• authority

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Compliance function and internal

controls

• help the company to not exceed the risk limits and not breach

regulatory requirements

• appropriate internal controls: quality, efficiency

• independent reporting line to the board

• fit and proper

• capacity

• authority

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To sum up

• Is there a connection between

the desired returns, established

capital, actually risk-taking and an

adequate risk management

program?

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Questions?

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Maria Haug Edvardsen

• Partner & Head of department

• Transcendent Group Norway

• mhe@transcendentgroup.com

• +47 992 711 80

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www.transcendentgroup.com