Dear Member,

EIOPA has a better sense of humor. Below is one interesting slide – from the official thoughts on the impact of Solvency II:

Companies try hard to find “fit and proper” risk managers, compliance officers and auditors. Fortunately, most actuaries are qualified.

Risk managers experience a massive increase in their take-home pay as a result of the Solvency II projects.

Below is an interesting job description. 

Risk Manager is needed, that will:

1. Provide specialist support to the Risk Team in the delivery of agreed Solvency II development and implementation plans,

2. Embed new or enhanced risk processes and be accountable for assigned project plan deliverables relating to Solvency II processes.

3. Design and execute the risk oversight framework for the Internal Model and supporting processes, including the drafting of oversight reports.

Interesting

Firms continue to lobby, to influence the final implementation of the directive.

Below there is an interesting example:

Lloyd's lobbying

Overview of Lloyd's Solvency II lobbying activities.

We want Solvency II to recognise Lloyd's unique structure and operations.

We don’t want Solvency II to put the market at a competitive disadvantage.

For this reason, Lloyd’s has been and is highly engaged in activity to influence the development of Solvency II legislation in Europe, alongside organisations such as the CEA in Brussels and the ABI and the IUA in London.

It is important for Lloyd's to retain an independent voice in the debate on Solvency II as well as influencing the input of bodies such as the CEA.

Although its positions are closely aligned with those of other insurers, there can be subtle, yet important, differences in emphasis and prioritisation.

‘Lloyd’s focus is on the regime’s impact on non-life insurers whereas some other major insurers in the UK and Europe are more concerned about proposals for the treatment of annuities and other issues primarily of interest to life insurers.

Lloyd’s also aims to ensure that policymakers in the UK are aware of its views.

Lloyd’s is represented at high-level meetings with the FSA and at ministerial level to address key industry concerns regarding Solvency II.

On 5 January 2011, Sean McGovern, Lloyd's Director, sent a letter to Managing Agents' CEOs and FDs with a view to providing an update on the Lloyd's lobbying approach for the development of Solvency II.

Lloyd's aims

To ensure that:

• The Market’s unique structure including regulatory recognition as a unitary organisation is preserved.

• The standard formula does not impose excessive capital requirements on undertakings.

• Internal model tests, standards and approval processes are reasonable and proportionate.

• The types of asset commonly held in the market are appropriately recognised.

• Additional administrative burdens on insurers are minimised.

• The competitiveness of the European industry is enhanced, not diminished.

Also interesting

Many countries continue to work hard to become Solvency II equivalent. Other counties do exactly the opposite. They try to advertise that they will never become equivalent.

Guernsey, for example, the largest captive insurance domicile in Europe, has decided not to seek equivalence under Solvency II.

According to Peter Niven, Chief Executive of Guernsey Finance: “The decision not to seek equivalence under Solvency II is based on the fact that under the current proposals, we would need to adopt measures that might undermine the competitive nature of our captive insurance industry".

Solvency ii Training

The members of the Solvency II Association have a 20% discount for the Certified Solvency ii Professional (CSiiP) and the Certified Solvency ii Equivalence Professional (CSiiEP) instructor-led classes.

Website: www.solvencyiitraining.eu

You may click “Register” after selecting the course location and date. The discount code to enter when registering for a course: sol20

News - Specifications for the 2011 EU-wide stress test in the insurance sector

In the second-half of 2009 CEIOPS coordinated an EU wide stress-test which involved 28 major European insurance groups, including three larger Swiss insurers.

The scope of the exercise was based on the List of 30 which had been previously agreed by CEIOPS Members.

The stress test was conducted in accordance with the mandate received from the EFC-FSC with the aim of testing the resilience of the largest and important insurance groups to adverse capital market developments.

The exercise was launched in November 2009 and aggregated results were reported by the national regulators to the CEIOPS Secretariat in January 2010.

Aggregated EU-wide results were reported back to EFC-FSC in March 2010 and high-level outcomes were disclosed to the public in the same month.

For future stress tests the EFC-FSC encouraged CEIOPS and CEBS in 2010 to coordinate the timing between the European banking and insurance stress tests.

The aim of this exercise is to receive information on the current vulnerability of the EU insurance sector to adverse developments.

At this juncture, priority is given to learning about the economic effects over implementing a supervisory tool.

This is why the cornerstones of this exercise are most current information (i.e. year end 2010 data), market valuation, distinct scenarios with rather different and also contradictory economic developments, and no reference to the current supervisory regime of Solvency I.

Although not part of the current supervisory toolkit, the insights gained through this stress test will be an input into the supervisory dialogue between colleges of supervisors/national supervisory authorities and participants, insofar as individual vulnerabilities appear too severe to tolerate.

As the stress test is not a test of the current regulatory requirements (Solvency I), but uses prospective measures in Solvency II and as much as possible uses specifications laid out for the last available impact study, any results, even when published on an aggregate level, need to be interpreted with this qualification.

As the stress test is not another QIS5 or a capital requirement and, at the same time, is based on a yet to be finalised future Solvency II regulation, the stress test will be conducted on a best effort basis and undertakings are able to use reasonable approximations, and proxies, where necessary.

In developing the stress scenarios due consideration was given to aligning the macro-economic assumptions with those applied to the stress test in the banking sector.

However, the specificities of the insurance business needed to be reflected in the design of the EIOPA stress test.

EIOPA Regulation Requirements

The new EIOPA regulation which came into force on 1 January 2011 enables EIOPA to “initiate and coordinate Union-wide stress tests in accordance with Article 32 to assess the resilience of financial institutions, in particular the systemic risk posed by financial institutions as referred to in Article 23, to adverse market developments, and evaluate the potential for systemic risk to increase in situations of stress, ensuring that a consistent methodology is

applied at the national level to such tests and, where appropriate, address a recommendation to the competent authority to correct issues identified in the stress test.” (Article 21 b).

Furthermore Article 23 stipulates that “the Authority shall, in consultation with the ESRB, develop criteria for the identification and measurement of systemic risk and an adequate stress testing regime which includes an evaluation of the potential for systemic risk that may be posed by financial institutions to increase in situations of stress.

The Authority shall develop an adequate stress testing regime to help identify those financial institutions that may pose a systemic risk.

These institutions shall be subject to strengthened supervision, and where necessary, to the recovery and resolution procedures referred to in Article 25.”

In addition, Article 32 (2) states that “the Authority shall, in cooperation with the ESRB, initiate and coordinate Union-wide assessments of the resilience of financial institutions to adverse market developments.

To that end, it shall develop the following, for application by the competent authorities:

a) Common methodologies for assessing the effect of economic scenarios on an institution’s financial position;

b) Common approaches to communication on the outcomes of these assessments of the resilience of financial institutions;”

Objective of the 2011 exercise

Building on the experience of the 2009/10 exercise and taking into account new EU regulatory requirements, the aim of this exercise is to test whether the insurance sector in the European Union will be able to meet the minimum capital requirement even after applying well defined stress scenarios.

The Solvency II capital requirements already are based on a certain level of prudence for similar risks.

For example, groups and undertakings will be required to hold capital at a level so that they can absorb a significant decline in equity prices - based, as much as possible, on the QIS5-Technical Specifications, although reasonable approximations and proxies may be used, where necessary.

In addition to these asset-related stresses, this exercise includes insurance-related shock scenarios in order to test the resilience of the sector to catastrophic or severe insurance events.

This exercise should also be seen as a precursor for the development of a future comprehensive stress test framework in accordance with the EIOPA regulation.

Scope of the exercise

The aim of this exercise is to reach a market coverage rate of at least 50% based on statutory gross written premiums per country in EU/EEA member states, split between life and non-life.

Similar to the previous stress test, the Swiss Financial Market Authority (Finma) has decided to join the Europe wide stress test.

Whilst the market coverage was calculated based on gross written premiums by solo undertakings, there is not necessarily a need for each undertaking identified by the national supervisors to carry out a separate stress test.

The exercise should be conducted on the highest level of insurance consolidation within the European Union or EEA.

This means that for the purpose of this exercise if these solo undertakings are part of groups which are participating in the stress test exercise, they do not have to submit individual stress test results

The stress test will thus include more than 200 insurers, including the largest European insurance groups.

Data collection and analysis

A best-effort principle applies to the 2011 stress test.

This principle has been employed for all QIS exercises or any other ad-hoc data request from EIOPA.

However, given the significantly shorter time-frame set out for this stress test exercise compared to a full QIS exercise, a reasonable use of approximations and proxies is envisaged under this stress test.

In order to ensure consistency and a level playing field, EIOPA offers the possibility to address open issues in a Q&A procedure.

All participants should register to the related mailing list in order to receive updates on such Q&As.

All questions and answers will be published on EIOPA’s website.

The (lead) supervisors of the respective insurance groups and undertakings will be responsible for co-ordinating the exercise on all participating companies/groups subject to their supervision.

EIOPA Members should ensure that results are submitted by the groups/undertakings in a timely manner and they should also validate individual results, in particular whether these are consistent with the previous assessments by national supervisors.

Following the collection of data the lead supervisor/national authority is then expected to submit the anonymised data to EIOPA for processing the results.

An example of data to be submitted to EIOPA is shown in Annex 1. EIOPA will provide the lead supervisor/national authority with a basic Excel IT tool to facilitate the delivery of the data.

The information submitted from the lead supervisors/national authority to EIOPA should also include a qualitative assessment following the validation process.

Main data to be delivered to EIOPA:

(a) Change and ratio of own funds compared with the MCR per individual group1/undertaking.

(b) Change in own funds per individual group/undertaking.

(c) Percentage contribution of the individual shocks to the change in own funds per individual group/undertaking.

(d) It is assumed that the political bodies FSC and EFC will receive indicative and aggregated information at a European level, without any reference to individual Member States, insurance groups or undertakings.

National supervisors should report aggregated results split between groups and solo undertakings.

The calculation of the MCR (derived from the SCR) should also be performed on a best-effort basis, i.e. both SCR and MCR. In order to derive the MCR on a best effort basis participants may, in close co-ordination with their relevant supervisor, include information based on QIS5, if appropriate.

Publication of results

EIOPA will publish the preliminary aggregated results of this exercise in early July. Due consideration will be given to the Solvency II-framework of this exercise, which will make interpretation of results an essential part of the analytical output.

This is why EIOPA sees no positive value in a possible publication of highly complex individual information, all the more so as the reference base – Solvency II specifications as in QIS5 – in itself might undergo changes while this exercise is performed and has indeed already been discussed in the preparation for the Solvency II implementing measures.

This being said, EIOPA expects valuable insights into the risk position of participants for the market in aggregate and for the individual supervisor to be obtained, as this information is based on fair valuation.

Further, this minimises possibly distorting effects of the Solvency I framework.

Timeline

March 2011

• 23 March: Launch of exercise

• 28 March: Workshop with participating groups/undertakings

May 2011

• 31 May: Results to be reported to national/lead supervisors

• Validation of results by national/lead supervisors

June 2011

• 14 June: Results to be reported by national supervisors to EIOPA

• Analysis of results and preparation of aggregate report

• 30 June: Briefing to EIOPA Board of Supervisors and Communication

July 2011

• Presentation of results to EFC

• Presentation of results to ESRB

• Public presentation of aggregated results

Reference date

The reference date for all scenarios is 31 December 2010.

Participating groups and undertakings should update the QIS5 results, which were previously submitted to national supervisors, for year-end 2010 financials on a best effort basis.

This includes updated discount rate curves to 2010 (both pre and post stress) following a methodology as much as possible similar to the one used under QIS5, but for simplicity for this exercise assuming no change in the liquidity premiums used, even though the illiquidity premium would in practice be expected to move in line with the market.

A table is provided by EIOPA as a supplement to this specification.

Participating groups from Switzerland should follow full Swiss regulatory requirements (i.e. Swiss Solvency Test).

This stress test model assumes that in the baseline and adverse scenarios the capital market stresses occur instantaneously and simultaneously on the reference date.

All other factors or assumptions remain unchanged in relation to the reference date.

EIOPA’s instant stress test model analyzes three “what-if-situations” or scenarios focusing on development on “market prices” on bonds, shares and technical provisions.

An instant model just compares a “what-if-situation” with the present situation.

This what-if-situation / instant model does not have an explicit time horizon.

The scenarios assume a simultaneous occurrence of the shocks for each capital market risk factor, so the risk correlation matrix for market and credit risks is assumed to be 1.

There will be only one set of insurance related stresses for life and non-life across the baseline, adverse and inflation scenarios.

However, a correlation adjustment should be made with other risks following overall Solvency II factors.

Consolidation

A world-wide consolidation for participating groups at the highest level of relevance for the group (including a holding company, if economically relevant) is required.

Insurance groups should follow the consolidation principles as set out in the QIS5 Technical Specifications.

For participating solo undertakings, their scope would encompass their activities as described below for groups and solo entities.

For simplicity reasons, only insurance activities and other non-banking participations are mandatory for inclusion in the exercise.

Consequently, banking activities are to be excluded from the scope of consolidation. If the banking activities are non-material to the group they can be included for simplicity.

In case of exclusion from the scope of consolidation, the book value of banking participations should be deducted from the available capital.

The value of non-controlled shareholdings in a non-insurance, non-banking subsidiary which is not subject to supervision or capital requirements should be included in the equity stress calculation.

For the purpose of this stress test exercise the QIS5 option of applying local rules for third countries should be included when assessing MCR and available own funds.

Valuation Approach

The previous stress test exercise was based on Insurance Group Directive (IGD)/Solvency I valuation requirements.

The limitations of this approach, in particular the non-comparable differences in valuation standards across Member states, were highlighted in the stress test results report to the EFC in March 2010.

In order to achieve better comparability and more realistic results, the 2011 stress test exercise will be based on future Solvency II principles. EIOPA acknowledges that there are shortcomings by referring to a framework which is seen as a testing environment and which is bound to change even whilst conducting this exercise.

However, for the purpose of gaining realistic and consistent information, EIOPA considers QIS5 specifications as being the closest proxy to the framework that should be the background for a stress test.

Although the QIS5 – Technical Specifications do not represent the final Solvency II requirements, the application, as much as possible of the most recent Quantitative Impact Study valuation and calculation guidelines overcomes some of the shortcomings of the first exercise.

Conducting a stress test based as much as possible on QIS5 rules will better reflect the risk profile of insurance groups and insurance undertakings thus allowing for better comparability and understanding of outcomes.

However, a reasonable use of approximations and proxies is expected, given the significantly shorter time-frame envisaged for this exercise compared to a QIS exercise.

In order to ensure consistency and a level playing field, the principle of such shortcuts should be addressed within the public Q&A procedure.

Participating groups and undertakings should therefore as default and, on a best efforts basis, follow the valuation approach as set out in the QIS5 – Technical Specifications and the QIS5 Q&A document and which formed the basis for the EIOPA Report on the fifth Quantitative Impact Study (QIS5) for Solvency II.

Swiss insurers should follow valuation requirements in accordance with the Swiss Solvency Test.

Stress Test Output

The aim of the stress test is to assess either the group solvency position or the solvency position of an individual undertaking, focusing on the level of own funds (i.e. available capital) before and after the stress test compared with the Minimum Capital Requirement (MCR) as a Solvency II measure.

Swiss groups will be assessed based on Swiss Solvency Test requirements.

The direct output of the stress test will be the reduction in available own funds after stress test shocks (scenarios), i.e. own funds as of end-2010 minus the change in own funds after the scenario.

This will be compared to the MCR.

Participants may recalculate the MCR level after the shock in each scenario, as this would more appropriately represent their solvency position.

However, for simplicity reasons, the pre-stress MCR will be the default numerator (i.e. in line with the best effort basis participants can opt for leaving the MCR unchanged post stress).

The output shall include some information on the contribution of the different shocks/risks to the change in own funds.

The Solvency II - MCR is used as a benchmark which is consistent with the aim of the stress test as it is deemed to be the ultimate intervention threshold for regulatory purposes whereas a breach of the SCR allows for a more flexible approach.

Swiss insurance groups should calculate their equivalent of the MCR (e.g. Threshold 3 in Circular 2008/44 SST).

EIOPA provides a stress test template in Excel format, comparable to QIS exercises, which will help to minimise misinterpretation of the framework and will produce the expected outcome in a way easily controllable by participants.

Loss-absorbing capacity

The loss-absorbing capacity of technical provisions and deferred taxes can be taken into account in line with the QIS5 – Technical Specifications (i.e. that participants exploit the means at their hands only within the current legal boundaries. See management actions in section 16)

For further details please see Section SCR 2 of the QIS5 Technical Specifications.

The loss absorbing capacity should be calculated on a best effort basis using one of the options outlined in the QIS5 Technical Specifications, but taking into account any legal requirements or restrictions regarding profit sharing and taxes.

Unit-linked business

In respect of unit-linked business, groups/undertakings should follow the approach as per the QIS5-Technical Specifications.

Indirect investments

The look through principle as set out in the QIS5-Technical Specification applies to indirect investments.

Hedging

Any existing hedging or other risk mitigations (e.g. derivatives and reinsurance) can be included in the stress testing, but only insofar as the hedging instruments have been in place at the reference date or if there is a contractual agreement with a counterparty that guarantees a downward protection if predefined capital market scenarios occur.

This also includes dynamic hedging where appropriate.

Where possible, groups/undertakings should report the impact of the hedging on the individual stress test results.

For the inclusion of potential management actions see section 16.

Management actions (post-stress)

In principle, stress test results should be calculated without taking into account risk mitigating actions (such as closing for new business).

However, groups or undertakings have the option to calculate stress test results without the impact of management actions (gross) and including the impact of management actions (net).

If this option is exercised, both gross and net outcomes would need to be reported to the national supervisors.

National supervisors will have to verify these management actions and provide an opinion whether the proposed actions are realistic.

For the purpose of considering management actions it is assumed that negative events occur six months prior to the reference date, so that groups and undertakings have time to initiate realistic actions.

However, they should have due regard to the fact that during a period of crisis not all proposed initiatives would be successful (such as a fire sale of assets or the implementation of a new hedging programme).

Stress Test Scenarios

This stress test framework comprises the following scenarios and modules:

For capital market and spread risks there are baseline and adverse scenarios.

There is also an inflation scenario which assumes an increase in inflation and which forces central banks to rapidly increase interest rates.

In developing the scenarios due consideration was given to aligning the macroeconomic assumptions with those applied to the stress test in the banking sector, in particular the assumptions underlying the macroeconomic adverse scenario provided by ECB.

The stress test also contains a set of insurance-specific stresses which are to be applied across the baseline, adverse and inflation scenarios.

All these stresses should be regarded as instantaneous shocks i.e. occurring on the reference date.

Further to these stresses two satellite scenarios on long term low interest rates and sovereign risk are to be conducted. 

Interest rate, equity, property, spread risk parameters

Interest rate risk

The ECB macro economic assumptions for market risks in respect of the development of interest rates reflect an upward trend in the adverse scenario.

However, insurers are typically more affected by a decline in interest rates either because of embedded guarantees in life insurance contracts or because of lower investment returns in non-life.

Consequently, the upward stress applied to banks will be used for the inflation scenario and the magnitude of this trend will be converted into a decline in the adverse scenario.

The floor of interest rate levels post the scenarios is zero.

Equity Risk

The ECB equity market assumptions in respect of the adverse scenario are very granular within the European Union.

In line with the current proposals under Solvency II and in order to facilitate the calculation of this stress module, a flat 15% decline for all equities in the adverse and 7.5% for the baseline scenario will be assumed by EIOPA.

Property risk

Residential property

In respect of property risk parameters the ECB has provided house price assumptions for 2011 and 2012 as a percentage deviation from the baseline scenario.

EIOPA has used the average percentage deviation for the two years 2011-2012 for the adverse scenario and the 2011 percentage deviation for the baseline scenario. It follows:

- Baseline scenario: 3.8%

- Adverse scenario: 11.6%

The stresses apply to all residential property world-wide.

Commercial property

Commercial property plays a significant role for insurers? investment strategy.

Based on the information available3 the following stresses apply:

- For all commercial property portfolios the decline in property prices during 2008 should be considered for the adverse scenario. Based on this, it assumes a 25% decline for the adverse scenario and a 12.5% decline in the baseline scenario (See table 1 in annex 2).

The stresses apply to all commercial property world-wide.

Spread risk

A 31.4% shock for investment grade bonds and a 38.3% shock for high yield bonds have been assumed.

This has been converted from actual option adjusted spreads (based on Merrill Lynch Bond indices as of 31 December 2010) applying an additional increase to actual spreads for investment grade.

News

The UK FSA's approach to the implementation of Solvency II

18 April 2011 - Speech by Julian Adams, Director of Insurance, the FSA

FSA Solvency II Conference

I want to update you today on some steps we are taking to make sure we can deliver our obligations under Solvency II.

Hector has just spoken about the context in which we are implementing the Directive and the drivers for change in our delivery approach. 

Later on, Paul will outline some of the main uncertainties and challenges

in the policy space. 

Here, I want to tell you more about what all of this means for you as firms, provide you with a greater degree of clarity as to what you will see and hear from us between now and the implementation date, and outline what we will be expecting of you in the coming months.

We are today making a number of announcements about our delivery approach – particularly in the area of internal model approval – which we believe, taken together, will provide us with the confidence that we need to have that our programme of work can be delivered in the time available to us, without compromising the standard of what we do. 

We need this confidence, because we have to be sure that we are discharging the obligations placed upon us by the Directive in a way that is appropriate and proportionate.

In the same way, I would expect all of you to review your programmes of work regularly to ensure that the delivery risk associated with them is appropriately managed, and that the timescales can be met. 

The EU policymaking process remains fluid, and the lack of clarity around the final policy position – and associated transitionals – means that we still do not have full clarity on what has to be in place for day one. 

We have made some assumptions, and we keep the position under review. 

What I will be saying to you today is based on our current view of the world, particularly that there will be full implementation on 1 January 2013. 

If this should change – although I should stress that we have no information at present that it will – we will naturally review our plans and may look again at our implementation approach. 

We would clearly expect firms to do the same.

Our current plans recognise Solvency II as a significant challenge, but one which both we and the UK industry are in a good position to meet. 

This is because we view Solvency II as an evolution of the regime which we have had in place here in the UK for a number of years, and we have fought very hard in Europe to ensure that many of the principles which underpin the current UK approach are present in the Solvency II regime. 

We also have a long-standing knowledge base of the firms we supervise, and we recognise that we are not starting from scratch when we come to review many aspects of firms’ activities.

Nonetheless, there are significant changes which both we and firms need to make to ensure that implementation is a success. 

The Directive brings about entirely new areas of responsibility for us, not least a significantly enhanced group supervision regime, and provision for model approval. 

These new responsibilities, along with the changes we need to make to other parts of what we do, mean that implementation of Solvency II is the largest programme of its type ever undertaken by the FSA.

This is partly because Solvency II is not only a new Directive which we have to implement, but is also something which will influence significantly the shape of, and approach to, insurance supervision in the Prudential Regulation Authority (PRA) when it is created. 

The PRA is due to assume its statutory responsibilities in early 2013, at around the same time as the implementation of Solvency II, and – as we build the new regulator – we will be embedding Solvency II in all that it does, whilst preserving the best of the FSA’s existing approach. 

One of the main reasons for our programme of work being so substantial is that we have a large and vibrant insurance market here in the UK, with a greater number of firms than in many other Member States. 

On top of this, firms have shown a very significant level of appetite for the use of internal models, possibly driven by the UK industry’s prior experience of modelling under the ICAS regime, but also probably driven by two specific aspects of the UK market. 

Here in the UK, firms write significantly higher levels of with-profits business than elsewhere in Europe, and this lends itself much more to an internal model approach. 

The same is true of the international catastrophe and specialist business written in the London market. 

All of these features mean that we have seen a large number of firms entering our pre-application process.

I want to be clear here that we do not necessarily regard developing a full model as being the only acceptable choice; nor do we necessarily regard use of the standard formula as being in some way second best. 

Whatever its deficiencies in some areas, the standard formula produces for some firms perfectly acceptable results, and we would expect firms to consider use of the standard formula for some risk modules, or some parts of their business. 

Nevertheless, the number of firms developing an internal model is significant, and I therefore propose to spend some time in a moment talking about our internal model approvals process – generally known as IMAP.

Before I do so, I want to touch first on some other aspects of Solvency II which have received a little less airtime so far, but are just as important and not optional – reporting and ORSA. 

First of all, Solvency II will bring about very significant changes to the reporting regime for all firms, whether they are using a model or not. 

From a regulatory perspective this is a considerable enhancement in the quality of the data we will receive, and in the way it is submitted to us and shared amongst supervisors across Europe. 

For the first time, all European supervisors will be receiving data from firms on a consistent, comparable and shareable basis. 

For firms, the new reporting regime will require changes to systems, and we will be requiring all firms to submit quarterly reports during 2013, and annual reports in respect of their 2013 year end. 

The UK-specific aspects of the reporting regime will be covered in our consultation process, and firms should engage fully with it both at that time and before via the Association of British Insurers (ABI) and our industry groups.

Solvency II also requires all firms to have sound governance, good internal controls and effective risk management across the whole of the business, not just the financial areas. 

All firms are subject also to the requirement to have in place an Own Risk and Solvency Assessment process – the ORSA. 

This is the principal means by which Solvency II draws together risk management, governance, controls and capital into a single picture which is squarely the responsibility of firms’ senior management and which must be used in decision making. 

Firms should ensure that all of these aspects of their business are compatible with Solvency II requirements, and that they have in place the processes to ensure that they can manage the ORSA successfully.

So, Solvency II is not just about capital requirements, and is not just about internal models. 

Nonetheless, our IMAP approach is something that I want to turn to now.

As responsible custodians of funds which we raise from you, the industry, we have to be sure that, when organising such a large programme of work, we are in a position to deliver it safely and ensure that those funds are properly deployed to the best effect. 

This is the approach we adopt in all of our work, and you will be familiar with the risk-based approach we have always taken to the allocation of our resources.

Given all of the constraints I have already talked about, we have looked again at our ability to deliver the IMAP process, along with everything else we are preparing to do before day one. 

We have considered the level of resources we are able to devote to firms going through the pre-application phase of IMAP, and have decided to concentrate these on a smaller population of firms – those firms representing a significant market share, and being those which we have always regarded as having the highest potential impact on our objectives. 

These firms will continue to receive the greatest intensity of review throughout the pre-application phase, with detailed reviews of various aspects of their model in accordance with a work plan which we will agree over the course of the coming weeks.

Specifically, these firms comprise the following sets: major UK life and non-life firms – broadly the UK top ten; firms which have operations in the Lloyd’s market; and firms which are subsidiaries of major European groups where we will be obliged to participate in a college of supervisors.

Other firms who are in pre-application will receive a reduced level of engagement. 

This will comprise a small degree of interaction with our actuaries and other risk specialists, supplemented as always by interactions with supervisors to ensure that firms remain on-track with their plans. 

We are proposing to develop various tools to facilitate our review. 

We think a number of these will assist firms in ensuring that their model development continues in the right direction and will help bridge the gap created by the reduced specialist input. 

The following are some examples of the kind of tools we are developing: 

1. Stress testing for general insurance firms;

2. Reference portfolios to test model treatment of certain types of asset or business;

3. Industry standards on catastrophe models; and

4. Specified models for certain esoteric types of firm.

More details on how these will work and the kind of firms to which we’ll be applying them will follow at a later date. 

We will be working with the ABI and others to ensure that we achieve a solution which meets our needs whilst not imposing undue additional burdens on industry.

At the same time, we will be introducing elements of external review into our approach, whereby we will allow firms to submit to us independent reports on some aspects of their model and how it works. 

The advantage of this approach is that firms get to see up front the areas in which we are particularly interested, and the FSA will receive independent reviews in a consistent format, which will help us to take decisions quickly and efficiently. 

We will be piloting this approach in the area of data very soon, and more details will follow later in the summer.

This lower level of specific specialist interaction for some firms should not be taken to mean that those firms will in some ways be held to lower standards than others. 

The Directive is clear that the same standards apply to all firms, and that is how we will implement it. 

We are merely being proportionate here in how we apply our internal resources to our investigations as to whether those standards are being met; and being proportionate in the level of engagement we are able to give to firms in the run-up to implementation.

I should also make it clear at this point that pre-application is now closed. 

This means that no more firms will be able to enter the pre-application process, which in turn means that firms which are currently not in pre-application should not expect to receive a pre-day one decision on an internal model, and they should therefore plan accordingly if they are not already doing so.

Supervisors are aware of the approach which is being taken for individual firms, and will be able to let you know soon what the work plan for your firm will look like, and the level of interaction you are likely to receive.

It would be useful also to highlight what this approach means and does not mean. 

First, being in pre-application does not guarantee a firm day-one approval of its model; it simply means that we are striving to be in a position to make a decision on that internal model application prior to day one. 

We cannot guarantee to be in a position to make a decision, as in part that depends on the quality and completeness of the application we receive. 

Second, the reduced level of attention devoted to some firms which I mentioned a few moments ago does not necessarily imply that those firms are less likely to have a decision prior to day one. 

By and large, the firms where we are applying our resources are the largest and most complex, and therefore those for whom the challenge of building and implementing a model will be the greatest. 

It is also important to stress that the FSA cannot make decisions about group internal model applications in isolation, as our ability to make a decision will rely on other supervisors’ agreement and engagement through pre-application and beyond, which is outside our control.

We have also reviewed and streamlined our processes to ensure that we make maximum use of the knowledge our supervisors already have about the firms that they supervise, and to ensure that we focus on the key judgements of maximum impact, making sure we get the most ‘bang for our buck’. 

Firms will begin to see the benefits of this approach as we agree work plans and move into the next stage of pre-application.

Whatever approach is taken to pre-application, the objective is for a firm to reach a point where it is able to submit a full application to us for model approval. 

Exactly what we look at after receiving this application will depend on the level of interaction we have had so far, and the extent to which firms have responded to the feedback we have given them previously, so the approach will be an individual one for each firm. 

What I can tell you today is that we will be open to receive those applications from 30 March 2012. 

This is later than we had originally envisaged, and reflects the dependency we all have on the EU policymaking process, and our need to be sure that we have as much clarity as we can on the policy position and the requirements which we are expected to meet, both in our own operations and in the firms which we supervise.

We currently envisage remaining open to receive formal applications for two months, meaning that any firm currently planning to submit a formal application later than the end of May next year is unlikely to receive a decision before day one.

Firms should be aware that our processes will be designed with regular review points, both during pre-application and after formal applications are received. 

If at any of these points we feel that a firm is likely not to be able to meet the required standards in time, we will be inviting firms to leave the process and invoke their contingency plans at these checkpoints along the way. 

As well as ensuring transparency and fairness for the firms involved, this will allow us to conserve our resources and focus them on those firms which have the best prospects of achieving model approval.

There are three possible outcomes of the model approval process:

1. Firms may have their models fully approved;

2. They may have them partially approved; or, in a small number of cases,

3. They may be rejected altogether, either because the application is incomplete, or because our review work continues to point to significant weaknesses. 

Two out of these three outcomes will require firms to have a contingency plan to fall back on, and I have alluded to this a number of times already.

This therefore seems an appropriate time to spell out in a little more detail what those contingency plans might be.

Firms will be aware that non-approval of a model application means that they revert to the default position under the Directive, which is to use the standard formula.  

This would apply either to the firm’s whole business (in the case of a complete rejection of the model) or to those parts not covered by the approved elements of a partial model. 

That is not quite as simple as it sounds because, where firms are using the standard formula, they have a responsibility to assess its suitability, and to be confident that it properly reflects the risks inherent in their business – this should be reflected in their ORSA. 

All firms – whether they are planning to use the standard formula, or because the standard formula is part of their contingency planning – should therefore take account – at the very least – of the extent to which this is the case, and the areas in which firms would need to make use of undertaking specific parameters, or other adjustments to the basic standard formula. 

Firms should also give consideration to the extent to which use of the standard formula would imply a much higher regulatory capital requirement than their own model, and explain to us what their approach would be to meeting those additional capital requirements, given that our decision on whether or not to approve their model would potentially come much later in the day.

I have attempted here to set out some of the immediate, major changes to our approach which will become visible to you in the coming weeks and months. 

Dear members,

The Solvency ii Association develops and maintains a compendium of Solvency ii related risk and compliance topics. Subject matter experts review and update this body of knowledge.

The Solvency ii Association offers two Solvency ii certification programs:

A. Certified Solvency ii Professional (CSiiP) for professionals working in the EEA countries

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Contact Ross Fenwick,  Managing Partner, Solvency II Training, Tel:  +44 (0) 207 060 3312, Fax: +44 (0) 207 681 3317, Email: info@solvencyiitraining.eu , Web: www.solvencyiitraining.eu

 

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For further information or to register for one of our Solvency II training courses, please contact:
Ross Fenwick,  Managing Partner, Solvency II Training Ltd, Tel:  +44 (0) 207 060 3312, Fax: +44 (0) 207 681 3317, Email: info@solvencyiitraining.eu , Web: www.solvencyiitraining.eu

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