SA3- legislation

Regulatory frameworks

Solvency II

Supervisory tools

Statutory actuarial roles
Two roles requiring practising certificates:

  • Chief actuary
  • Lloyd's Actuary/Syndicate Actuary

Need:

  • Technical competency- provide evidence to show they are fit for role
    • Financial and criminal background check
    • Confirm you apply with current actuarial standards and codes
    • Prove you have done required CPD in last 12 months

Chief Actuary
Two certificates- non life with Lloyd's and non life without Lloyd's


Specific technical requirements:

  • Considering appropriate reserving bases and methodologies for valuing assets and liabilities
  • Pricing bases
  • RI arrangements
  • Measuring, managing and mitigating issues and risk to which an insurer is exposed
  • Assessing capital requirements

Lloyd's Actuary
Provide details about the work you have done in the last four years , particularly last 12 months, which demonstrates experience of setting reserves in London MArket

Rulebooks
Sets out rules that a company must abide by:

  • communication- how they can market
  • data holding
  • sales e.g. cooling off period
  • claims e.g. how quickly claims must be paid

Solvency II requires a large number of info items before a policy can be written

Reporting requirements
So the regulator can monitor certain characteristics of a company. Reporting requirements can be both qualitative and and quantitative

Objectives
Give confidence
Reduce financial crime
Inefficiencies in market corrected
Protect consumers

A risk based approach to prudential requirements which brings harmonisation at the EEA level.
Aims to provide good incentives for risk management


Applies if gross premium income greater than 5m euro or gross TPs greater than 25m euro

Pillars

Pillar I
Comprises quantitative requirements including risk based capital requirements

Pillar II
Need effective corporate governance which provides sound and prudent management of business
Organisational structure must have clear segregation of responsibilities. Written policies in respect of:

  • risk management
  • internal control
  • internal audit
  • actuarial

Pillar III
Reporting and public disclosure


Reporting

  • Quantitative templates
  • Regulatory Supervisory Report (RSR) which includes solvency calculation details and risk management details
  • ORSA

Public Disclosure
Solvency and Financial Condition Report (SFCR). Quantitative templates, solvency calculation details and risk management processes

Solvency balance sheet

Valuation of assets
Assets valued at amount they could be exchanged between knowledgeable willing parties in arm's length transaction. Use of quoted market prices is default approach but may also use modelled amounts.


Recoveries from RI are included as assets

Eligible capital
'Own funds' refers to basic own funds (assets less liabilities) plus ancillary own funds, which are then tiered based on specific criteria.


Basic own funds- capital which already exists within the insurer e.g. ordinary shares


Ancillary own funds- letters of credit, guarantees and calls on members of mutual to contribute capital


Split this into three tiers based on loss absorbency and permanency


Restrictions on quality of capital to cover MCR and SCR

  • 80% of MCR must be Tier 1
  • Tier 3 cannot cover MCR
  • 50% of SCR must be covered by Tier 1 capital
  • No more than 15% of the SCR may be covered by Tier 3 capital
  • Restrictions on amount of capital used as coverage e.g. preference shares

Technical Provisions
Amount insurer would have to pay to transfer its obligations immediately to another insurer


Comprise premium provisions (relating to future claim events covered by contracts that are required to be included in TPs) and claims provisions (relating to claims already incurred whether reported or not) and are the sum of best estimate and a risk margin

Best estimate
Probability weighted average of future cashflows, discounted to allow for time value of money.


Should be no margin and must use all relevant available data, both internal and external


Use interest rate swap rates allowing for credit risk for risk free rates

Risk margin
Calculated cost of capital to compensate firm taking on liabilities for needing to hold SCR over the lifetimes of the liabilities. Just for risk which cannot be hedge e.g. extreme market risk, credit RI reinsurance risk, insurance risk


  1. Estimate future development of SCRs in the future
  2. Multiple by cost of capital- currently 6%
  3. Discount using relevant risk free rate

Can be reduced to take account of diversification

Premium provisions
Best estimate of future cashflows in respect of unexpired exposures rather than unearned proportion of written premium

Contract boundaries
Need to set assumption for the boundary of an existing insurance contract. Under Solvency II this is when:

  • can unilaterally terminate the contract, refuse to accept premium or
  • amend the benefits or premium in such a way that the premium fully reflects the risk

Within the boundary need to consider contractually renewing premium and premium arising from policyholder option to renew on a best estimate basis

Legal obligations basis for unincepted contracts
Not yet incepted but cannot be waived or reduced by the company. Material where:

  • delegated authority business
  • brokers write business
  • year end renewals written before 1 Jan
  • tacit renewal agreements where automatic renewal unless policyholder decides to move

Data quality
Delegated Regulation contains requirements on data quality. Crucial because:

  • consistent, accurate final estimates
  • allows application of wider range of methodologies
  • validation of methods more reliable
  • effective comparisons over time and to market data

Minimum Capital Requirement
Calculated by taking the greater of:

  • a factor applied to technical provisions (not including the risk margin) for each line of business, net of reinsurance, subject to a minimum of zero
  • a factor applied to written premiums in each line of business over last 12 months, net of RI, subject to minimum of 0

Intention is the MCR is calibrated to VaR of basic funds subject to confidence level of approximately 85% over a one year time horizon

Solvency Capital Requirement
Calibrated to VaR of basic funds subject to 99.5% confidence level over a one year time horizon


Must cover at least: underwriting risk, market risk, credit risk and operational risk


Can use:

  • standard formula with simplifications
  • standard formula
  • standard formula with undertaking specific parameters
  • partial internal model
  • full internal model

Standard formula
SCR= BSCR + Adj + SCR(op)


BSCR
BSCR= sq.root(Total(Corr.i.j. x SCR.i. x SCR.j))+SCR.intangible
There is a set correlation coefficient matrix

Operational risk
Greater of 3% of gross earned premiums during the previous 12 months and 3% of gross technical premiums. Maximum of 30% of basic SCR. No diversification allowance between op risk and others

Adjustment
Could include the loss absorbency of deferred taxes as e.g. if equity gains fall then tax lower, would be pushed back in event of a shock scenario
Therefore acts to offset the capital needed. Deferred tax liability within best estimate liabilities remains unchanged

Non-life underwriting
Set standard deviations- similar to MCR but higher. Multiply by 3 to get the 99.5% VaR.
Also multiple by factors representing XOL reinsurance- only motor vehicle liability, fire and general liability business (80% factor applied)
Scope to reduce factors by 25% to allow for geographical diversification


Allowance also made for diversification by line of business. Also 0.5 correlation coefficient between premium risk and reserve risk


Non life CAT risk
Complex series of sub modules for each type of CAT risk

Market risk
Different factors applied to different investment types. Multiply this by market value of the asset to get capital required.


Interest rate capital reqmnt- stress yield curve by specified percentages, varying by term to maturity.

Counterparty default risk
Differentiates between:

  • Type 1- consist of small number of counterparties which are usually rated e.g. RIs. Based on loss distribution derived from loss given defaults and default probs
  • Type 2 exposures- if diversified mix and not rated. Based on immediate shock assuming losses of 90% and which have been due for more than 3 months and 15% on other receivables

Internal model
Appropriate if risk profile of business differs materially from that underlying standard formula or if they already use and internal one.


Could have to hold less capital


IMAP


Must pass following tests:

  • use test- difficult to embed and start risk culture. Also hard to evidence this is the case
  • statistical quality standards- quality of data to calibrate extreme events is limited. Setting correlation factors is often difficult
  • calibiration standards
  • profit and loss attribution
  • validation standards
  • documentation standards

Tight deadline of six months for regulatory body to grant approval. But have set up a pre-application process. This involves regular meetings to discuss

Use test
Demonstrate use throughout business- internal governance, risk management and decision making processes

Statistical quality standards

  • methods used to calculate prob distributions forecast based on adequate and relevant actuarial and statistical techniques
  • methods used based on current and credible info
  • data used is accurate, complete and appropriate
  • can take account of dependencies within and across risk types if system for measuring is adequate

Calibration standards
Provides policyholder equivalent to VaR of 99.5% of basic own funds over a one year time horizon
Different time period or risk measure can be used as long as gets to equivalent level of protection

Profit and loss attribution
Annually, insurance and RI undertakings are required to review and explain how the risk chosen in internal model corresponds to profits and losses by business unit

Validation standards
Monitor performance, review appropriateness of specification and test against experience

Documentation standards
Document the design and operational procedures

Risk management function
Need strategies, processes and reporting procedures to identify, measure, monitor, manage and report the risks they could be exposed to. Must cover each risk type. If have internal model then needs to cover all aspects of internal model e.g. test, document

Internal control

  • administrative and accounting procedures
  • internal control framework
  • appropriate reporting arrangements at all levels of the undertaking
  • compliance function

Internal audit
Evaluates adequacy and effectiveness of internal control system. Must be objective and independent

Actuarial function

  • coodinate the calculation of TPs
  • ensure the appropriateness of the methodologies and underlying models used as well as the assumptions made in the calc of TPs
  • assess the sufficiency and quality of the data used in the calc of TPs
  • compare past best estimates against experience
  • inform the supervisory body of the reliability of the calculation of the TPs
  • express opinion on overall underwriting policy
  • express opinion on adequacy of RI
  • contribute to effectiveness of the risk management system

ORSA
Own risk and Solvency Assessment- goes beyond the MCR and SCR
Requires identification of all risks to which the firm is subject to- will likely include more than just those modelled in Section I
Must quantify ability to continues to meet the MCR and SCR over the business planning horizon, allowing for new business


Includes the following components:

  • assessment of overall solvency needs (considering specifics to the firm)
  • compliance with capital requirements and TPs
  • consideration of extent of deviation of risk profile from that assumed in modelling

Performed annually and must be reported to regulator.


Looks at all the stuff you'd expect and need to document all this- data, methodology, sensitivity, uncertainty, peer review

SFCR and RSR includes

  • system of governance applied by undertakings
  • business they are pursuing
  • valuation principles
  • risks faced
  • risk management systems
  • capital structure
  • system of governance

Application to insurance groups
Solvency II enables supervision more efficiently through a 'group supervisor' in the home country. Each group must cover group SCR, allowing for diversification benefits across the group. Each subsidiary needs to cover its own SCR


'Third country'- country outside EEA. If group based here additional rules apply but if country has similar rules then can get 'third country' equivalence.

Impact

  • optimal business mix and product design
  • optimal asset mix
  • corporate structure (think diversification benefits)
  • management info changes
  • impact on market of external disclosures

Lloyd's

Capital assessed at three levels:

  • Overall
  • Syndicate
  • Member/names

Overall
Capital made up of New Central Fund plus other central assets. Combined with FALs this must be able to withstand solvency test against total of all syndicate's exposure

Capital requirements for Lloyd's syndicates
Submit SBF and Lloyd's Capital Return (LCR) (contains detailed info on SCR)


Lloyd's scrutinises SBF and asks questions.


Ultimate SCR used to set capital on behalf of each syndicate. May be loaded if not high enough. Multiplied by 35% (to maintain Lloyd's credit rating_ and called Economic Capital Assessment


Lloyd's allocates capital amount needed to be be put up to Lloyd's Names/members

Funds at Lloyd's
Money from Names. Held in trust


Lodged as assets or Letter of Credit from bank. LoC must meet:

  • Appropriate level of rating of the bank
  • Be available throughout a specified period usually four year- 'evergreen'
  • Under SII must be approved as ancillary funds

Members can get LoC at low cost by collaterising other assets. But can invest these assets in higher paying investments. Works out less expensive but bank will charge rate for LoC representing investment risk of collaterised assets

FAL held at member level, just for open YOAs not for each YOA separately. Credit given for diversification between syndicates.


Detailed simulation model used to model experience of each member. From this, an overall distribution of losses beyond FAL is derived


Lloyd's SCR calculated on two bases:

  • Market Wide SCR- all capital consumed in 1 in 200 whatever the source
  • Central SCR- central capital needed at 1 in 200

Once each member's capital requirements has been calculated a minimum of 40% of Overall Premium Income Limit (member capacity)= premium gross of RI and net of brokerage.


In line- members tested twice a year that they have at least FAL equal to capital requirement


Solvency deficits- if liabilities are greater than Premium Trust Funds the members have solvency deficits. Counted against FAL. If member's FAL can't meet PRA test then central assets may be earmarked


Coming into line- Lloyd's has power to require members to lodge further assets

SAO
Produced under Lloyd's valuation of liabilities rules which are influenced by actuarial guidance.

Met by:

  • ensuring companies remain solvent to pay policyholder claims
  • ensuring companies treat policyholders fairly
  • requiring all employees to take training so they can identify financial crime