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SWITZERLAND SWITZERLAND

INFO@INCUBEGROUP.COM

INCUBEGROUP.COM

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Solvency II

Preparatory Phase – What needs to be done next?

Zurich, November 2014

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Overview

• What is our experience – How we might support you

• Introduction – What is Solvency II?

• Preparatory Phase – What needs to be done next?

• Solvency II project examples

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Introduction – What is Solvency II?

What is Solvency II?

• Solvency II defines capital and risk management requirements to be applied across all EU Member States and establishes uniform reporting standards for insurance undertakings. The new supervisory regime uses a more principle- and risk-based approach and thus facilitates a more flexible supervision.

• Solvency II will be applied across all 28 EU Member States and in three Member States of the European Economic Area. As a European standard, Solvency II is meant to assist in protecting the interests of policyholders by reducing the probability that insurance undertakings become insolvent.

When will Solvency II come into force?

• It was planned that Solvency II should be fully applied as of 1 January 2014. However, the Omnibus II process was interrupted by the Long Term Guarantees Assessment and was not resumed until the second half of 2013 which meant that postponement of the scheduled implementation date was inevitable.

• On 13 February 2013, the negotiators of the European Parliament, the Council and the Commission reached an agreement on the Omnibus II Directive according to which the start date of Solvency II will be 1 January 2016.

• The agreement also stipulates that the Member States must implement Solvency II by 31 March 2015. The early implementation date is to provide time to establish a legal basis for certain authorization applications. It will thus be possible for insurance undertakings to apply for authorization of their internal model as early as April 2015 and obtain approval by 1 January 2016.

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Introduction – What is Solvency II?

Preparation for Solvency II

Insurance undertakings should use the time between 1 January 2014 and 1 January 2016 to get ready for Solvency II. EIOPA has issued Preparatory Guidelines to help undertakings to prepare for those Solvency II requirements which were not affected by the Omnibus II negotiations. The Preparatory Guidelines are applicable as of 1 January 2014 and addressed to the supervisory authorities which are expected to actively support the insurance undertakings in the preparation for Solvency II.

What will change as a result of Solvency II?

Undertakings to which Solvency II applies will be subject to considerable changes with regard to capital and own funds requirements, the valuation of assets and liabilities and supplementary provisions concerning business organization and reporting and disclosure obligations. Additional changes will be made with regard to provisions on group supervision. The established capital investment principles will be supplemented to the extent that undertakings will in future be required to provide capital backing for their investments, which is to be calculated on the basis of the risk involved in each investment (see Article 101 of the Solvency II Directive).

Which undertakings will be subject to Solvency II?

Both primary insurers and reinsurers will be subject to Solvency II, irrespective of their legal form. A first indication of the applicability of Solvency II is when the annual gross written premium income of a primary insurer or a reinsurer exceeds EUR 5 million or its gross technical provisions, calculated under Solvency II requirements, exceed EUR 25 million. Further information, in particular on exemptions from the requirements of Solvency II, can be found in Articles 4 to 12 of the Solvency II Directive.

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Preparatory Phase – What needs to be done next?

• Early preparation is essential for meeting the new requirements that will apply when Solvency II becomes effective. The Europe-wide phase for the preparation for Solvency II was launched on 1 January 2014. The European Insurance and Occupational Pensions Authority (EIOPA) published its guidelines for the preparation of Solvency II on 31 October 2013.

• Guidelines aim to ensure compliance with Solvency II requirements in 2016. The EIOPA guidelines are intended to ensure that every undertaking affected by Solvency II can meet the new regulatory requirements in full when they come into effect on 1 January 2016. How undertakings prepare for Solvency II in detail and the order in which they take the necessary implementation measures is left to the discretion of each individual undertaking.

• Both supervisors and undertakings as target audience of the guidelines. The guidelines are aimed directly at national supervisory authorities who are required to make every effort necessary to comply with the EIOPA guidelines and recommendations.

• Compliance of National Supervisory Authorities. National supervisory authorities were required to report to EIOPA by 31 December 2013 whether they intended to apply the preparatory guidelines in their supervisory practice.

Structure of the preparatory phase

The guidelines are thematically divided into four areas:

Requirements for business organization and risk

management

Forward-looking assessment of own risks

(FLAOR)

Internal models – pre-application phase Reporting

Aim and purpose of the preparatory guidelines, target audience

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Preparatory Phase – What needs to be done next?

Pillar 1: Quantitative rules

• The first pillar of Solvency II essentially lays down the quantitative rules. It not only contains rules governing the valuation of assets and liabilities, but also lays down capital requirements and rules relating to own funds. The aim is to ensure that undertakings have adequate capital backing at all times. Valuations must be consistent with the market, in other words consistent with the information provided by financial markets.

Pillar 2: Governance rules – Business organization & risk management; ORSA/FLAOR

• The second pillar of Solvency II contains qualitative requirements applicable to the system of governance, i.e. the business organization of undertakings. Solvency II requires undertakings to maintain, among others, the following key functions:

− Risk management function;

− Compliance function;

− Actuarial function; and

− Internal audit function.

• An effective risk management system must also be put in place and maintained. A key component of risk management systems are the “forward looking and own risk and solvency assessments” (FLAOR/ORSA) which tie risk management to capital management.

Pillar 3: Governance rules – Reporting

• The third pillar of Solvency II essentially contains the requirements governing the undertakings' reporting of information both to the supervisory authority and to the public. A Solvency and Financial Condition Report (SFCR), to be published annually, and a Regular Supervisory Report (RSR), to be submitted to the supervisory authority at least every three years, will be required. Both reports predominantly, although not exclusively, contain qualitative information. Reporting forms containing quantitative information on undertakings will also be introduced. The existing reporting requirements are being revised in light of the new reporting regime in order to avoid duplications.

Solvency II – Three pillar structure

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Preparatory Phase – What needs to be done next?

Principle of proportionality relevant even during the preparatory phase

• The guidelines are subject to the principle of proportionality inherent in Solvency II – even though this is not expressly mentioned. The principle of proportionality works in both directions: While undertakings with a very complex structure and a high risk exposure must meet high expectations the requirements for less complex and less risky undertakings may not be so significant. The principle of proportionality is not merely guided by the size of the undertaking. Rather, it implies that application of the guidelines has to be weighed against the type, extent and complexity of the risks to which an undertaking is, or could be, exposed to.

• Undertakings have a responsibility to develop a plan for the implementation of the requirements that is proportionate for them and can be justified to their regulator.

Reporting – participation important for thorough preparation

• Some regulators (e.g. Bafin) urges the undertakings and groups concerned to participate in the planned voluntary test runs for quantitative and narrative reporting from mid-2015 (no threshold applied since all undertakings are expected to take part).

Forward-looking assessment of an undertaking’s own risks (FLAOR)

• As part of the forward-looking assessment of their own risks, all undertakings and groups affected by Solvency II should assess their overall solvency needs based on the preparatory guidelines and report them to the regulator from 2014.

Important aspects in the preparatory phase

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What is our experience – How we might support you Pillar 1: Quantitative focus

Implemented Risk Modules for the Standard Formula Approach

• SCR calculations for:

− NatCat, ManMadeCat, HealthCat NL Underwriting Risk

− Life Underwriting Risk

− Market Risk

− Counterparty Default Risk

− Operational Risk

− Aggregation

− Implementation of complete SII Standard Formula and Internal Model approach on server applications

− Implementation of complete SII Standard Formula approach within Excel

• MCR calculations

• Risk margin calculations

• Own funds calculations

• Balance sheet validations

• Ring fenced funds

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What is our experience – How we might support you Pillar 2: Qualitative focus

Definition of key functions and policies

• Definition of key control functions:

− Risk Management (key control & policy) including risk assessment (quantification)

− Internal Audit (key control & policy)

− Actuarial Function (key control & policy)

− Compliance Function (key control & policy)

− Internal Control (internal control systems) (key control & policy)

• Definition of further policies:

− Fit & Proper requirements

− Outsourcing

• ORSA/FLAOR

− Own Risk and Solvency Assessment (ORSA) / Forward Looking Assessment of Own Risks (FLAOR) policy

− Own Risk and Solvency Assessment (ORSA) / Forward Looking Assessment of Own Risks (FLAOR) report

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What is our experience – How we might support you Pillar 3: Reporting

Reporting

• Quantitative Reporting Templates (Interim Measures completed (annual / quarterly); Full QRTs ongoing)

− Solvency Capital Requirements (SCR); Minimum Capital Requirements (MCR) QRTs

− Basic Information

− Balance Sheet; Currency Balance Sheet

− Technical Provisions (Life / NL)

− List of Assets; Open Derivatives

− Ring Fenced Funds

• Narrative Reporting (RSR, SFCR)

• ORSA Reporting

• Experience with different commonly used SII reporting solutions

• Performed business mappings to reporting solution (field by field mapping)

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Client’s challenges

Development of the Solvency II Standard Formula application integrated into the in-house risk modeling platform

Multi-user web application deployed to over 25 countries

Definition of flexible solutions and processes in order to benefit from the synergies between the Solvency II internal models and the Solvency II standard approach despite regulatory uncertainties

Very short timeframe from prototype to productive solution while pursuing production of the current framework

Our role

Project management and coordination of the technical work stream

Support in business requirements analyses and in the delivery of technical specifications

Coordinate and specify interface to group wide DWH

Design and implementation of the productive solution for the Solvency II Standard Approach

Unit testing, support of UAT testing, documentation and training

Continuous support and further development of the application together with the client

Client benefits

Flexible and customized Solvency II Standard Approach solution accounting for the “dynamic” regulatory requirements

Open system (no “black box”) allowing in-depth analysis of intermediate results and fast adaptation for impact studies and scenario analyses

Single partner from prototype to productive system including business support and maintenance

User Management

GUI

Workflow Engine

Input Data File Repository Users

Analytical Engine

Hardcopy Reports

DB / Warehouse

Group DWH

Dynamic Reporting Tool

Microsoft SQL Server HTML5/JavaScript, EXTJS Java EE, Scala, Akka,

ActiveMQ C#, .NET S+/R Analytical Server Tibco Spotfire

Solvency II project example Implementation of the Solvency II Standard Formula Approach at a large international insurance group

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Out- sourcing (Art. 49)

Internal Control (Art. 46)

Own Risk and Solvency

Assessment (Art. 45)

Risk- Management

(Art. 44)

Fit & Proper

(Art. 42 / 43)

General Governance

(Art. 41)

Actuarial Functions (Art. 48)

Internal Audit

(Art. 47)

Directive text refers to the administrative, management or supervisory body

(Art. 40)

Solvency II Pillar 2 expectations: In order to be compliant with Pillar II, companies have to demonstrate an adequate governance, risk management

and supervisory review processes. The governance system shall at least include an adequate, transparent organizational structure with a clear

allocation and appropriate segregation of responsibilities and an effective system for ensuring the transmission of information.

Main topics to be fulfilled by the companies are: Control functions:

− Risk Management − Internal Audit − Actuarial Function

− Compliance Function − Internal Control (internal control systems)

Further policies:

− Fit & Proper requirements − Outsourcing − Own Risk and Solvency Assessment (ORSA)

Pillar 1 Pillar 3 Pillar 2

Market Discipline

Solvency and Financial Conditions Report

(SFCR)

Regular Supervisory Reporting (RSR)

Quantitative Reporting

Templates (QRT)

Capital Requirements

Solvency Capital

Requirements (SCR)

Minimum Capital Requirements (MCR)

Technical provisions

Investments rules

Solvency II Framework Client’s challenges

Extensive and, in some cases, complex (and partially incomplete) regulatory requirements

Challenging organizational setup due to lean management structure

Short timeframe in order to fulfill requirements

Lack of internal resources

Our role

Led the gap analysis of current setup and regulatory requirements

Set up appropriate organizational structure in order to comply with regulatory and governance requirements

Structured the company’s Pillar 2 work into various components

Developed all policies (general governance, fit & proper, risk management including risk appetite, ORSA, internal control, compliance, internal audit, actuarial functions and outsourcing)

Facilitated the company's vision setting for each Pillar 2 component

Coached and educated key stakeholders to support the Solvency II Pillar 2 requirements

Ensured compliance of implementation and documentation with superior group structure and group requirements

Client benefits

Structured approach in order to fulfill all regulatory as well as group-wide requirements

Flexible and lean project management

Fully auditable documentation

Risk Management / Supervisory Review

Own Risk and Solvency Assessment (ORSA)

Governance

Supervisory Review Process

Solvency II project example Pillar 2 Implementation at a life insurance company

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Client’s challenges

Fulfilling the extensive regulatory reporting demands

Challenging data requirements to achieve the traceability requirements

Alignment of regulatory reporting with data and risk/calculation models

Lack of internal resources and interface capabilities between the business and software developers

Moving from ORSA to ORSA / FLAOR

Our role

Led the gap analysis in comparison to the required reporting requirements

Led the analysis on whether data is locally or centrally available

Aligned data to the reporting templates

Set up of calculation methodology and implementation of calculation

Prepared reporting input data templates and reporting files

Tested new application releases which automate the process

Project management/lead

Client benefits

Structured approach to help to facilitate the reporting process

Documentation of gap analysis, release testing and project development

Tailored solution and implementation of reporting process

QRT and ORSA / FLAOR reporting at a large international insurance group

Content of the submissionS.01.01.a

Template Code Template nameS.01.02.a Basic Information A1

S.02.01.a Balance Sheet A2

S.06.02.a List of assets A4

S.08.01.a Open derivatives A5

S.12.01.a Life and Health SLT Technical Provisions A6

S.17.01.a Non-Life Technical Provisions A7

S.23.01.a Own funds A8

S.28.01.a Minimum Capital Requirement A19

S.28.02.a Minimum Capital Requirement - Composite A20

Appendix I: Quantitative reporting templates

Content of the submissionS.01.01.b

Template Code Template nameS.01.02.b Basic Information A1

S.02.01.b Balance Sheet A2

S.02.02.b Assets and liabilities by currency A3

S.06.02.b List of assets A4

S.08.01.b Open derivatives A5

S.12.01.b Life and Health SLT Technical Provisions A6

S.17.01.b Non-Life Technical Provisions A7

S.23.01.b Own funds A8

S.25.01.b Solvency Capital Requirement - SF A9

S.25.02.b Solvency Capital Requirement - PIM A10

S.25.03.b Solvency Capital Requirement - IM A11

S.26.01.b Solvency Capital Requirement - Market risk A12

S.26.02.b Solvency Capital Requirement - Counterparty default risk A13

S.26.03.b Solvency Capital Requirement - Life underwriting risk A14

S.26.04.b Solvency Capital Requirement - Health underwriting risk A15

S.26.05.b Solvency Capital Requirement - Non-Life underwriting risk A16

S.26.06.b Solvency Capital Requirement - Operational risk A17

S.27.01.b Solvency Capital Requirement - Non-Life Catastrophe risk A18

S.28.01.b Minimum Capital Requirement A19

S.28.02.b Minimum Capital Requirement - Composite A20

Appendix I: Quantitative reporting templates

S.26.01.bSolvency Capital Requirement - Market risk

Simplifications used

Simplifications - spread risk - bonds and loans ? (Y/N) A00Captives simplifications - interest rate risk ?(Y/N) AA01Captives simplifications -spread risk ?(Y/N) AA02Captives simplifications - market concentration risk ?(Y/N) AA03 para. IX.2 Normalisation para. X.2 Normalisation

No change in the business templates No change in the business teMarket risk - basic information

Assets Liabilities Assets

Liabilities (including the loss

absorbing capacity of technical

provisions)

Net solvency capital requirement (including

the loss-absorbing capacity of technical

provisions)

Liabilities (excluding the loss-

absorbing capacity of technical

provisions)

Gross solvency capital requirement (excluding

the loss-absorbing capacity of technical

provisions)

Interest rate risk C0 D0

interest rate down shockA1 A1A B1 B1A C1 B1B D1

interest rate up shock

A2 A2A B2 B2A C2 B2B D2

Equity risk C3 D3type 1 equities A4 A4A B4 B4A C4 B4B D4

type 1 equity A5 B5strategic participations (type 1 equities) A6 B6duration-based (type 1 equities) A7 B7

type 2 equities A8 A8A B8 B8A C8 B8B D8type 2 equity A9 B9strategic participations (type 2 equities) A10 B10duration-based (type 2 equities) A11 B11

Property risk A12 A12A B12 B12A C12 B12B D12

Spread risk C13 D13bonds and loans A14 A14A B14 B14A C14 B14B D14

credit derivatives C15 D15downward shock on credit derivatives A16 A16A B16 B16A C16 B16B D16upward shock on credit derivatives A17 A17A B17 B17A C17 B17B D17

tradable securities or other financial instruments based on repackaged loans

A18 A18A B18 B18A C18 B18B D18

Market risk concentrations A19 A19A C19 D19

Currency risk A20 A20A C20 D20

Counter-cyclical premium risk A21 A21A B21 B21A C21 B21B D21

Diversification within market risk module C22 D22

Total capital requirement for market risk C23 D23

Initial absolute values Absolute values after shock

Appendix I: Quantitative reporting templates

S.26.04.g S.26.05.g

Solvency Capital Requirement - Non-life underwriting riskSimplifications used

Captives simplifications - premium and reserve risk (Y/N) A001

Non-life underwriting risk Standard deviation for reserve risk

Premium and reserve Risk - Basic information

USP Standard Deviation

USP Adjustment

factor for non-proportional reinsurance

USP Vprem VresGeographical Diversification V

Motor vehicle liability A1 A1A B1 C1 D1 E1 F1

Motor, other classes A2 A2A B2 C2 D2 E2 F2Marine, aviation, transport (MAT) A3 A3A B3 C3 D3 E3 F3Fire and other property damage A4 A4A B4 C4 D4 E4 F4Third-party liability A5 A5A B5 C5 D5 E5 F5Credit and suretyship A6 A6A B6 C6 D6 E6 F6Legal expenses A7 A7A B7 C7 D7 E7 F7Assistance A8 A8A B8 C8 D8 E8 F8Miscellaneous A9 A9A B9 C9 D9 E9 F9Non-proportional reinsurance - property A10 A10A B10 C10 D10 E10 F10Non-proportional reinsurance - casualty A11 A11A B11 C11 D11 E11 F11Non-proportional reinsurance - MAT A12 A12A B12 C12 D12 E12 F12

Total Volume measure Total Volume measure F13

Appendix I: Quantitative reporting templates

Standard deviation for premium risk Volume measure for premium and reserve risk

Solvency II project example

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Client’s challenges Solvency II requires insurance firms to perform an attribution of profits and losses

(P&Ls) for validating the Internal Model and satisfying the Use Test

Develop and implement a P&L attribution methodology that creates added value for risk and financial management of the firm and fulfills regulatory requirements

Scarce know-how and manpower to implement the methodology and test the implementation

Our role

Developed logical data model that satisfies the requirements for completeness, consistency, flexibility, and robustness

− Definition of logical data model and design of SQL table structure

− Specification of data sourcing and processing rules

Developed Excel prototypes to refine the methodology and to provide reference outputs for the S-Plus implementation

Implemented S-Plus applications based on the Excel prototypes that integrate seamlessly into the existing IT landscape

− Implementation of S-Plus applications

− Design of reporting templates for the presentation of results

Tested the implementation and computational engines

− Specification of quality parameters and reconciliation of data and results

− Feedback to application development based on reconciliation results

Client benefits

P&L attribution implementation that satisfies the Solvency II requirements and adds additional value for management

Custom tailored solution that accounts for the specific needs and requirements

Transparent design and implementation process that allows the client to take part in decision-making

Existing IT landscape

Data (SQL and file repository)

Methodology

Excel prototypes

• Insurance business • ALM: fixed income • ALM: other positions • Other P&L

components

Accounting data

• Accounts • Versions • As-of-dates • Currencies • Values • Reporting units • ...

Meta data

• Account information • Reporting hierarchies • Information required for

mapping and aggregation • Country and currency

information • ...

Common data

• FX rates • Interest rate curves • ...

Securities data

• Position information • Transactions • Security details • ...

S-Plus implementation

• Insurance business • ALM: fixed income • ALM: other positions • Other P&L

components

Reconciliation Reports

Actuarial data

• Payment patterns • Loss ratios • Expense ratios • ...

Solvency II project example Internal model validation - P&L Attribution – Prototyping, implementation and testing

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INCUBE GROUP ROSENWEG 3 BRANDSCHENKESTRASSE 41 CH-6340 BAAR/ZUG CH-8002 ZURICH SWITZERLAND SWITZERLAND

INFO@INCUBEGROUP.COM INCUBEGROUP.COM

Dr. Andreas Felber

Partner

E-mail: andreas.felber@incubegroup.com