Category Archives: Solvency II

Solvency II: Recalculation of the Transitional Measure on Technical Provisions

For many firms, year-end 2017 will be the first time that they need to recalculate the Transitional Measure on Technical Provisions (TMTP relief), although some firms have already applied and received approval for a recalculation following material changes in their risk profiles.

Milliman consultants have experience in recalculating the TMTP relief for a number of clients, performing independent reviews of recalculated TMTP relief, and have provided assistance with the development and review of firms’ recalculation policies.

This update by Milliman’s Oliver GillespieEmma Hutchinson, Marie-Lise Tassoni, and Stuart Reynolds summarises findings from these exercises, along with our own views on different potential approaches to recalculating the TMTP relief and associated key issues and challenges.

Judging the appropriateness of the Standard Formula under Solvency II

The Standard Formula (SF) aims to capture the risk that an average European (re)insurance company is exposed to. The SF may not be appropriate for all (re)insurance companies, but the majority of European insurers currently uses it. In this article, Milliman’s Steven Hooghwerff, Sinéad Clarke, and Roel van der Kamp provide a short overview of the SF’s structure. They also present a suggested framework and worked examples, and discuss challenges and pitfalls to be considered.

SFCR: Under the bonnet – insurers’ assets

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

Following the first annual reporting deadline under Solvency II, here’s a look at a breakdown of investment assets held by Irish insurance companies.

All companies
The figures below are based on an analysis of the investment breakdowns found in the Solvency and Financial Condition Reports (SFCRs) of 51 insurance companies in Ireland, which include all the major players in the Irish insurance market. Please note that these investments do not include assets held for unit-linked or index-linked contracts. Instead they represent the assets backing technical provisions and shareholder investments.

Note: The chart above shows the net derivatives position, i.e., derivative assets less derivative liabilities.

On average, Irish insurers are heavily invested in bonds, with 41% in government bonds, followed by 35% in corporate bonds. There are also significant holdings in cash and deposits (9%), listed equities (4%) and collective investment undertakings (5%).

The chart below shows the various market sectors in more detail.

Domestic life companies are heavily invested in government bonds, which account for 64% of their total investments, followed by corporate bonds, making up 22%.
• For life cross-border companies, there is a wider distribution across investment types, with the highest allocation of investments to government bonds (32%), followed by corporate bonds (23%), cash and deposits (17%), collective investment undertakings (11%) , listed equities (10%) and derivatives (6%).
Reinsurers are heavily invested in corporate bonds, which account for 56% of their investments on average, followed by 33% invested in government bonds. This may indicate that the large global reinsurers are prepared to take on a little more risk, in order to gain a higher spread.
• When we look at non-life companies, we can see their investments are almost equally split between government bonds (37%) and corporate bonds (38%).

In terms of more unusual assets, we see a wide range of assets included in the ‘Other’ category in the market sectors chart above, although these investments are typically low. Investments in the ‘Other’ category include property, mortgages/loans and collateralised securities in the form of mortgage-backed securities.

The public disclosure templates do not reveal the duration of investments held. Therefore it is not possible to get a picture of how well matched the asset portfolios are to the associated liabilities. However, a comparison with the investment mix and the market risk component of the Solvency Capital Requirement (SCR) of the various market sectors shows the following:

• For non-life insurers, the market risk component of the SCR is much lower than for life insurers even though the investment mix is broadly similar. This is typically due to the fact the non-life insurers invest in short-term assets, which tend to attract lower capital requirements.
• For life insurers, the domestic insurers have a higher market risk component than the cross-border insurers. This is counterintuitive to the asset mix, which shows that the domestic insurers are more heavily invested in government bonds that are traditionally considered to be less risky and attract no capital charge for spread risk under the Solvency II standard formula. It is not clear from the SFCRs what is causing this but it may be that the domestic insurers are investing in assets of a longer duration to back long-term liabilities, such as annuities, or it could be that the unit-linked policyholders of the domestic insurers are investing in riskier assets than their cross-border counterparts.

SFCR: Capital insights

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

Following the first annual reporting deadline under Solvency II, we look at the quality of the Own Funds on Irish company balance sheets.

All companies
The figures below are based on an analysis of 46 Solvency and Financial Condition Reports (SFCRs), which cover all the major players in the Irish insurance market. The headline statistic is that Tier 1 unrestricted Own Funds account for 93.7% of capital on Irish insurers’ balance sheets, as shown in Figure 1. Tier 1 restricted (1.1%), Tier 2 (2.9%), and Tier 3 (0.8%) make up the remainder of basic Own Funds. The small level of ancillary Own Funds (1.5%) shows that very few companies have applied to include additional ancillary items on their balance sheets.

Solvency II_Own Funds Breakdown_All Companies
Figure 1

Life industry
It is useful to consider companies selling life business in isolation. We have included 25 published SFCRs within this category.

Firstly, in Figure 2, we look at domestic life companies selling in Ireland. For these companies, a minimum of 90% of Own Funds is Tier 1 unrestricted capital. Please note that Irish Life redeemed €200m of Tier 1 restricted capital in February 2017. Thereafter their Own Funds were 100% Tier 1 unrestricted capital.

Figure 2

In fact, as seen in Figure 3, all these domestic companies are covering 100% of the Solvency Capital Requirement (SCR) using Tier 1 unrestricted capital.

Solvency II_SCR coverage
Figure 3

We see a similar picture in Figures 4 and 5 for the cross-border life market in Ireland, with very few cases of lower-quality capital on the balance sheet. Again, all the companies examined cover the SCR using 100% Tier 1 unrestricted capital.

Figure 4
Figure 5

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Recovery plans: A natural extension of the ORSA

Recovery and resolution1 plans (RRPs) are becoming increasingly important for insurance and reinsurance companies. A requirement to develop RRPs already applies to global systemically important insurers (G-SIIs) and in some territories we are also seeing requirements coming into force which apply to smaller insurers that have not been classified as G-SIIs. In Europe, for example, the European Insurance and Occupational Pensions Authority (EIOPA) is looking at the area of recovery and resolution planning, with Gabriel Bernardino stating that ‘One of the lessons learned from the recent financial crisis is the need to have in place adequate recovery and resolution tools which will enable national authorities to intervene in failing institutions and resolve failures when these materialise in an effective and orderly manner.’2 This speech was followed by the release of an EIOPA discussion paper on the potential harmonisation of recovery and resolution frameworks for insurers.

This blog post offers a look at the link between RRPs and the Solvency II Own Risk and Solvency Assessment (ORSA).

ORSA requirements
One of the key aims of the ORSA is for insurers to identify and measure the risks that they face, with a view to either holding capital against these risks, or taking steps to manage or mitigate them. This process is called the insurer’s assessment of its overall solvency needs.

Guideline 7 of the Solvency II Level 3 Guidelines on the ORSA covers this assessment. It says that, “The undertaking should provide a quantification of the capital needs and a description of other means needed to address all material risks ….”

The explanatory text of this guideline expands on the factors to be considered by companies in deciding whether to cover risk with capital or to use risk mitigation techniques. These considerations include the following:

• If the risks are managed with risk mitigation or recovery techniques, the (re)insurer should explain the techniques used to manage each risk.
• The assessment needs to cover whether the company currently has sufficient financial resources and realistic plans for how to raise additional capital if and when required.
• The assessment of the overall solvency needs is expected to at least reflect the (re)insurer’s management practices, systems and controls, including the use of risk mitigation techniques.
• When assessing the overall solvency needs, the company should also take into account management actions that may be adopted in adverse circumstances. When relying on such actions, companies should assess the implications of taking these actions, including their financial effect, and take into consideration any preconditions that might affect the efficacy of the management actions as risk mitigators. The assessment also needs to address how any management actions would be enacted in times of financial stress.

Based on some of the ORSA reports that I have seen, companies are generally good at identifying possible risks and projecting their solvency positions allowing for the impact of these risks. Companies are also quite good at using the results of such analyses in determining capital buffers as part of the assessment of their overall solvency needs. Furthermore, as required by Solvency II, companies tend to have capital management plans in place, identifying possible shortfalls in own funds and how they might be addressed. However, some of these plans are often quite vague in terms of companies’ prospects of raising capital in the event of financial distress. In such cases, parents might not be willing or able to provide capital and the investment markets might also prove difficult to access.

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SFCR: Where are the risks?

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

Following the first annual reporting deadline under Solvency II, here’s a look at the breakdown of risk components within the Solvency Capital Requirement (SCR) across the Irish market. This provides a useful insight into the largest drivers of regulatory capital, while also indicating some of the sources of risk for companies.

All companies
This analysis is based on 40 published Solvency and Financial Condition Reports (SFCRs) as only standard formula companies have been included. The graph in Figure 1 shows the breakdown of the various SCR components, where 100% represents the calculated SCR.

As can be seen, underwriting risk represents the largest driver of SCR, followed by market risk. In this case, underwriting risk represents a combination of life, health, and non-life underwriting risks.

The benefits of diversification and loss-absorbing capacity represent an average reduction of 43% of the SCR. Please note that diversification here is at the SCR module level and doesn’t include the impact of diversification across sub-modules.

Figure 1

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