Category Archives: Solvency II

Central Bank of Ireland review of Solvency II life insurance pricing and reserving assumptions

In February 2017, the Central Bank of Ireland published letters on its website relating to its review of the consistency of Solvency II life insurance pricing and reserving assumptions. This briefing note by Milliman’s Aisling Barrett and Sinéad Clarke summarises the contents of these letters. The authors also reference the contents of the December 2016 industry letter on the standard formula Solvency Capital Requirement.

Annual QRTs: Getting it right first time, every time

This blog is part of the Pillar 3 Reporting series. For more blogs in this series click here.

Over the next few weeks, companies will be finalising their first sets of annual Quantitative Reporting Templates (QRTs) to be submitted under Solvency II. For companies with a financial year-end of 31 December, the reporting deadline is 20 May 2017.

A key part of preparing the annual (or quarterly) QRTs is ensuring the accuracy of the information provided. In this blog post, we highlight some validation processes available to companies.

In recent speaking engagements and publications, the Central Bank of Ireland (CBI) has underlined the importance of ensuring that the supervisory returns are validated and that there is appropriate governance in place so that the directors, who sign off on the annual QRTs, are satisfied that the returns are accurate and complete. In its recent Insurance Quarterly bulletin, the CBI stated that its ‘experience to date has shown that successfully meeting the dual requirements of “fit for purpose” and “right first time” requires firms to manage much better the governance and operational risks around the reporting process.’

Pressure to put in place a validation and governance process also comes from the board as the annual QRTs must be approved at a board level under the Solvency II text. In addition, in Ireland three named directors are required to submit an accuracy certificate on the annual QRTs. The CBI points out that ‘while those signing off returns may not be the people reviewing them, they should ensure that they have a clear process that they can rely on.’

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SFCR: Some more reports published

This blog is part of the Pillar 3 Reporting series. For more blogs in this series, click here.

Two new Solvency and Financial Condition Reports (SFCRs) were published in the past week. In both cases, the financial reporting date is 31 December 2016, representing an impressive turnaround time for public disclosure. They are both useful examples of Group SFCRs:

• St. James’s Place Group prepared a single SFCR encompassing the public disclosures for the Group and all of the solo entities within the Group with two life company subsidiaries.
• ASR understood it is a Group SFCR and so each of the solo entities has prepared separate SFCRs. ASR has published the public Quantitative Reporting Templates (QRTs) in a separate document which is available on the same web page as the SFCR report.

Company Link Country Reporting Date
St James’s Place Group Link UK 31/12/2016
ASR Group Link

Link

Netherlands 31/12/2016

Compliance risk: Box-ticking or ticking all the boxes?

‘Box-ticking’ can be a phrase synonymous with poor practice in Enterprise Risk Management (ERM). When poorly executed it can mean going through the motions to display minimum levels of compliance, rather than engaging in any meaningful activity that would deliver any real benefit. Such an approach is not encouraged by regulators.

However, do companies, and indeed individuals, spend enough time making sure they have ticked all the boxes from a compliance perspective? This is an activity that regulators certainly encourage.

With the general direction of regulatory oversight and the formality of Solvency II, companies and boards are now confirming compliance in many areas. There is a risk that the compliance process itself becomes a risk. Compliance risk is one of those intangible issues that can’t be quantified using actuarial models or managed through setting aside capital. It is a risk that is dealt with on a qualitative basis and is managed and controlled rather than measured and capitalised. This means that managing compliance risk might not be front of mind for many companies, especially with such a focus on capital amounts and getting the numbers “right”.

This becomes even more apparent at this time of year, when statutory sign-offs and certifications come into play. If you are being asked to put pen to paper to certify compliance or sign-off on the accuracy of regulatory submissions, how do you know that all the requirements have been adequately met?

The implementation of Solvency II significantly increased the amount of requirements and guidance that companies and individuals have to follow in relation to certifying solvency. This is in addition to increased compliance in other areas over the last number of years, including the Corporate Governance Code in Ireland, policyholder disclosures, etc. A lot of governance tasks that would have developed over time based on industry knowledge and practical sense now have to run the rule against a checklist or a set of requirements.

The very nature of financial reporting is changing to fit this new world. Getting the numbers right is no longer enough, you now also have to evidence how you ensured the figures are accurate and reliable and not misleading. In a Solvency II world the sheer number of requirements (and the very prescriptive and specific nature of some of them) means that the only way to be sure that each and every requirement is covered is to sit down and mark each item off. It is boring, and it doesn’t feel particularly efficient or creative—but it is disciplined and leads to identifying areas for improvement. Going through this value-adding process of identifying and closing gaps in a systematic way clearly is valuable and can help you spot patterns over time. It is also the best way of documenting and demonstrating compliance.

Being able to demonstrate compliance is also a defensive requirement in this new Solvency II world. If an issue arises or a query is raised by a regulator, the drawbacks of ignoring compliance checks quickly become apparent. Your ability to defend what you do now from a challenge in the future depends on your audit trail. So as a parting thought—don’t be afraid to spend some time ticking boxes. It might be more valuable that you think.

The Milliman Solvency II Compliance Assessment Tool distils the Solvency II requirements into easily digestible self-assessment questions and allows insurers to track and evidence their compliance with all the requirements of Solvency II. The tool is already being used by 25 entities in Ireland and the UK. For more information click here.

The emergence of lapse risk transfer

This blog post is part of an ongoing series of blog posts on capital efficiency. To see past posts in this series, please click here.

In recent months, we have seen the emergence of lapse risk reinsurance following the introduction of Solvency II. Lapse risk is one of the key risks that life insurers, and particularly unit-linked life insurers, are exposed to and it is a key component of the Solvency II Solvency Capital Requirement (SCR) for many life insurers. One of the benefits of lapse risk reinsurance is that it can be used to reduce the life underwriting risk capital charge, in addition to reducing the undertaking’s exposure to lapse risk. Many reinsurers are active in this area, and as undertakings begin to consider Solvency II capital efficiency in more detail, it may be an area where we will see further growth during 2017.

Reinsurance treaties
The nature of lapse risk transfer will depend on the most material lapse risk exposure of the cedant—either mass lapse, lapse up, or lapse down.

The mass lapse scenario under Solvency II is calibrated as an instantaneous loss of 40% of the in-force business (for retail business). While the actual occurrences of mass lapse scenarios are difficult to predict, the risk of lapses exceeding 20% to 30% in a given period may be low based on historical data. Reinsurers can therefore offer treaties that cover losses caused by lapses in excess of 20% to 30% in a given period, often setting a maximum threshold of 45% to 50%. In reinsurance parlance, the reinsurance treaty attaches at a level of 20% or 30% and detaches at 45% or 50%. The relevant period would be defined in the reinsurance treaty. The cedant would retain the risk exposure to lapses below the attachment point and above the detachment point.

We are also aware of some reinsurers considering lapse up and lapse down reinsurance. However, there may be significant practical challenges associated with lapse reinsurance of this nature, in particular with regard to defining when an increase or decrease from the long-term average, or best estimate, lapse rates has occurred.

Considerations
There are a number of general considerations in respect of lapse risk reinsurance (as well as other potential considerations, depending on the specific terms of an individual treaty). First of all, there is the premium charged by the reinsurer for transferring lapse risk. The cost is generally set with reference to the reduction in SCR achieved by the transaction. We understand that costs generally vary between around 2% to 3% per annum of the reduction in the lapse risk SCR, depending on the type of deal and the availability of data.

Buy-in from the regulators will be key for these contracts to be effective. There is likely to be a concern that reinsurance could be used to reduce the SCR without a real reduction in the underlying risk. It is difficult to argue that there is no reduction in lapse risk exposure in the example attachment points outlined above. However, it may be more difficult to justify real risk transfer where the treaty is set up in such a way as to only indemnify insurers when a mass lapse of exactly 40% occurs.

Other considerations include the following:
• The interaction between the different lapse risk components of the SCR needs to be considered. If the risk exposure to mass lapse is reduced through the use of reinsurance, the lapse up or lapse down risk module may bite instead. Therefore, the impact of mass lapse reinsurance will be limited to the margin over which the mass lapse SCR capital charge exceeds the next-highest lapse risk capital charge. Understanding this interaction will be an important factor in determining the optimal attachment point for a mass lapse reinsurance treaty.
• Reinsurance introduces additional risks to the balance sheet such as counterparty risk, which is also considered in the Solvency II SCR calculation.
• The impact of such a transaction on the financial statements or International Financial Reporting Standards (IFRS) balance sheet should also be considered.
• If the reinsurance contracts are short-term in nature, there may be a risk associated with getting renewal terms on the same basis.

An alternative
Insurance-linked securities offer an alternative approach to transferring risk compared with traditional reinsurance. Under these transactions, insurance risk is effectively securitised and bought by capital investors through an investment fund. We are aware of a number of insurance-linked security firms that are active in transferring lapse risk.

The solutions can be structured in a similar way to traditional reinsurance deals in terms of attachment and detachment points, although the deals tend to be longer in term than traditional reinsurance contracts (circa three to five years, as opposed to 12 to 18 months). This provides additional benefits in terms of impact on the Solvency II risk margin and also may be more preferable to regulators than short-term contracts. However, this results in slightly higher costs compared with traditional reinsurance deals.

One disadvantage is that insurance-linked security firms generally do not have credit ratings, which can result in a high capital charge for counterparty risk under Solvency II. However, it is possible to reduce this through the use of collateral.

SFCR: A taste of what’s out there

This blog is the first part of a series on Pillar 3 reporting for Solvency II.

For most companies with a 31 December year-end, the first annual reporting deadline under Solvency II is on 20 May 2017. In preparation for this I think it’s interesting to look at some of the first examples of published Solvency and Financial Condition Reports (SFCRs).

What does an SFCR really look like?

To date, a number of companies with year-ends before 31 December have published their reports and I have included links below:

Company Link Country Reporting Date
Evolution Insurance Company Ltd Link Gibraltar 30/06/2016
Vitality Life Ltd Link UK 30/06/2016
The Wren Insurance Association Ltd Link UK 30/06/2016
Care Insurance Co Link Gibraltar 30/06/2016
Cornish Mutual Assurance Co Ltd Link UK 30/06/2016
Euroguard Insurance Co PCC Ltd Link Gibraltar 30/06/2016
Hansard Europe dac Link Ireland 30/06/2016
International Diving Assurance Ltd Link Malta 30/06/2016
Municipal Mutual Insurance Ltd Link UK 30/06/2016

While clearly a small sample, there is a variety of company types, lines of business, and territories represented in the selection above. In addition to the Solvency II requirements themselves, looking at what others have published can provide a useful reference point as you prepare your own SFCR report. As a health warning, it should be noted that these SFCRs represent approaches taken by some individual companies and can’t yet be taken as established market practice. We also have no feedback yet on the expectations and views of the various European supervisors.

Differences in approach

While the Solvency II requirements are generally clear on what should be included in the SFCR, as always there is scope for different interpretations. Furthermore, it is a general principle that the SFCR should be proportionate to the nature, scale, and complexity of the undertaking. It is therefore reasonable to expect variations in the length and level of detail in these reports. It is worth remembering that the SFCR is a public document for policyholders and other key stakeholders.

How long is a piece of string?
Looking at the nine publicly available SFCRs mentioned above, there is a wide variation in length, with the shortest report coming in at 24 pages, while the longest is 73 pages.
The longest section on average is the System of Governance chapter (B), while the shortest section is on Capital Management (E).

 Number of pages Average Min Max
A. Business and Performance 4.1 1.5 7.0
B. System of Governance 8.9 3.0 17.0
C. Risk Profile 5.4 1.5 10.0
D. Valuation for Solvency Purposes 4.9 2.0 10.0
E. Capital Management 3.0 1.0 5.5
Appendix: Public QRTs 19.1 5.0 39.5
Total 45.3 24.0 73.0

Layout
Generally, the SFCRs follow the order of required contents set out in the Level 2 Delegated Regulations Article 292 to 297, and the corresponding Level 3 Guidelines (with Chapters A to E, and subsections A1, A2, and so on). I think this is a sensible structure as it is easy for the reader to follow and ensures consistency across the industry.

Where a particular reporting requirement doesn’t apply to a company, most SFCRs still include the section and give a reason why it is not applicable. In cases where firms simply skip the section, it becomes difficult for the reader to determine whether it is not relevant or whether they didn’t complete it for another reason.

You are required to disclose your public quantitative reporting templates (QRTs) together with your SFCR. In almost all cases, the public QRTs are included as an Appendix.

Presentation
As a publicly available document, some companies have ensured their SFCRs are consistent with their brand and other policyholder documentation—Vitality Life is a useful example here. On the other hand, a number of other companies have taken a more functional approach, with very little additional formatting. This choice probably depends on how likely policyholders are to access your SFCR and whether you view it as marketing material.

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