Solvency 2

Question 1

Comparisons to the US Solvency Regime:

Solvency II

Answer 1

process that links the required capital to the insurer’s specific risk profile

attempts to figure out how much capital / surplus a company should hold

Question 2

3 pillars of Solvency II

Answer 2

1) Quantification: capital requirements quantified
2) Governance: supervisory activities
3) Transparency: supervisory reporting and public disclosure

Question 3

Pillar 3) Transparency: supervisory reporting and public disclosure

Answer 3

Showing the reporting of IC position to both the supervisors as well as the public

Question 4

Pillar 1: Quantification: capital requirements quantified

(most testable)

Answer 4

Calculates free surplus which is based on the following:

1) Solvency capital Requirement
- The required capital limit the probability of ruin over the year to 0.5%
- a company with lower capital is subject to regulatory intervention

2) minimum capital Requirement (MCR)
- a company with lower capital will lose its license and not be permitted to operate

3) technical provisions
-include reserves and risk margin
-similar calculation as P_GAAP, where cost of capital exceeding the risk free rate (R-i) = 6%

Question 5

Pillar 1: Quantification: capital requirements quantified

Solvency capital Requirement

Answer 5

calculated using:
1) standard formula provided by the regulator
-Similar to the RBC used in US
-conservative

2) internal models: will need to obtain approval to use this by regulators/independent third party
-can potentially be manipulated
-more tailored to the company to provide a more appropriate capital requirement
-can be difficult to calculate and company needs to come up with this specialized model
-will typically produce lower capital requirements than the standard

3) mix of both

Question 6

Free Surplus

Answer 6

Free Surplus = Assets - Technical Provisions - SCR

Excess Surplus thats available on top of the SCR (Solvency capital requirement)

Company can do whatever they want with this (i.e engage in riskier investments, return to owners, etc)

MCR will be a component of the SCR.

Question 7

Pillar 2) Governance: supervisory activities

Answer 7

focuses on activities of the regulators

provides supervisors with:

1) means of identifying firms with higher risk profile

2) power to intervene

requires insurers have implemented a governance structure to address the following FUNCTIONAL AREAS:
1) Internal Audit
2) Actuarial
3) risk management
4) Compliance
5) ORSA

Question 8

Pillar 2) Governance: supervisory activities

FUNCTIONAL AREAS:
Internal Audit

Answer 8

produce a report at least annually to the board about:

-deficiencies od internal controls

-shortcomings in compliance with internal policies

Question 9

Pillar 2) Governance: supervisory activities

FUNCTIONAL AREAS:
Actuarial

Answer 9

ensure methods and assumptions used to derive the technical provisions are reasonable

perform a retrospective analysis of best estimates vs. experience

opine on the overall underwriting policy and adequacy of reinsurance arrangements

Question 10

Pillar 2) Governance: supervisory activities

FUNCTIONAL AREAS:
Risk Management

Answer 10

monitor the risk management function

ensure the internal model has been integrated with the risk management function

there should be a feedback loop between the model and the risk management function

(i.e information from the risk management function should be parameterizing the internal model. and the findings from internal model can be used to refine the risk management strategy)

Question 11

Pillar 2) Governance: supervisory activities

FUNCTIONAL AREAS:
Compliance

Answer 11

ensure that internal control system is effective to comply with all applicable laws and regulation

promptly report ant compliance issues to the board

Question 12

Pillar 2) Governance: supervisory activities

FUNCTIONAL AREAS:
ORSA

Answer 12

Own risk and solvency assessment

an internal assessment of the solvency need based on the risk profile

At minimum ORSA should contain info about:
-overall solvency need based on risk profile, tolerance, business strategy
-compliance with capital requirements and requirements of the technical provision (MCR and SCR)
-extent to which the risk profile deviates significantly from the assumptions underlying the SCR

results from ORSA need to be reported periodically

Question 13

Pillar 3) technical provisions

Answer 13

focuses on increasing the transparency of the insurer’s risk and capital provision

includes including and disclosing the capital position derived from pillars 1 and 2 to the supervisor and financial markets:
intention: give the market sufficent info to exercise its disciplinary function

i.e if company isnt operating appropriately -> impact the stock price -> cost more money to get loas -> interest rates will increase -> employees will not want to work / may need to pay them more -> policy holders may not want to pay high premiums.

Question 14

SMI - solvency modernization Initiative

Answer 14

Solvency 2 is designed to be a group wide solvency regime

Whereas US regime is focused on the regulation of individual atatutory entities

Question 15

ORSA Continued

Answer 15

3 key areas that the ORSA summary report should cover that will help provide state commissioners with a high level understanding of insurers’ ORSA

1) Description of the insurer’s risk management framework (i.e

2) Insurer’s assessment of the risk exposure (i.e shows quantitative and/or qualitative assessment of the risk exposure in a normal and tressed environment)

3) Group assessment of Risk Capital and Prospective Solvent Assessment (i.e looking at IC’s process to asses capital adequacy and how it is embedded into the management culture)