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Solvency II and the Swiss Solvency Test. János Blum. Casualty Loss Reserve Seminar San Diego, 11 September 2007. Contents. Swiss Solvency Test Industry Engagement -Test Runs. Swiss Solvency Test. Swiss Solvency Test.

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Solvency II and the Swiss Solvency Test

János Blum

Casualty Loss Reserve Seminar

San Diego, 11 September 2007

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  • Swiss Solvency Test

  • Industry Engagement -Test Runs

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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 longterm guarantees

  • Accounting and regulatory arbitrage

  • Compliance culture

  • Abrogation of responsibility to the regulator

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New Insurance SupervisionAct 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

  • 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

  • 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

  • The internal model has to be integrated into the core processes within the company

  • SST Report to supervisor such that a knowledgeable 3rd party can understand the results

  • Public disclosure of methodology of internal model such that a knowledgeable 3rd party can get a reasonably good impression on methodology and design decisions

  • Senior Management is responsible for the adherence to principles

  • All assets and liabilities are valued market consistently

  • Risks considered are market, credit and insurance risks

  • 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

  • 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

  • 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

  • Under the SST, an insurer’s capital adequacy is defined if its target capital is less than its risk bearing capital

  • The scope of the SST is legal entity and group / conglomerate level domiciled in Switzerland

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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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  • 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

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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

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SST - Breakdown of SCR & MVMApproximative Numbers

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SST – Historic Scenarios - LifeApproximative Numbers

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Breakdown of Insurance Risk – P&CApproximative Numbers

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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