Cicero Policy Briefer

Issue 27, August 2008

Solvency II—An industry view

By Jacquie Curness, Chief Actuary, Unum

The ink has now dried on Unum’s response to the fourth Quantitative Impact Study (QIS), which closed in July following four months of consultation on the latest draft requirements under the proposed solvency regime. The QIS process, run by the Committee of European Insurance and Occupational Pension Supervisors (CEIOPS) at the request of the European Commission, has provided the industry with key insights into how the forthcoming legislation will have an impact on their capital requirements, and has allowed us at Unum to engage actively with policymakers in making amendments to these rules.

We are now awaiting with anticipation formal responses to the study from the FSA and CEIOPS, due out this autumn, and while the process for making these technical measures has shown improvement, there are still some creases to be ironed out.

In comparison to Individual Capital Assessments (ICA), we have noted that current proposed rules will require us to hold more conservative technical provisions as a result of the addition of a Risk Margin on top of the best estimate provisions; in fact, it is at very similar levels to the current prudent Solvency I liabilities. This Risk Margin represents the future capital requirements of the existing business at the valuation date at the end of one year. Further, the Risk Margin uses a conservative cost of capital at 6 per cent (as was the case for QIS3), which not only includes underwriting risk from future Solvency Capital Requirements (SCR) but also SCR at time 0, increasing RM by 7 per cent.

The calculation of the SCR continues to be a sticking point in both European Parliament discussions as well as in deliberations within CEIOPS. At the forefront of our concerns as a disability insurer is the level of detail that is prescribed to specialist or monoline insurers. Currently, all disability risks are still included in the Life underwriting module instead of under the Health module. This raises the question of whether to favour an internal model, or at least a partial internal model, to calculate our SCR or whether to use the Life module, as set down, which is currently resulting in a need for over-conservative capital requirements. In making this decision, we are awaiting the realisation among regulators that this module still needs tweaking in order to work more efficiently and balanced across other modules. In QIS4, a ‘Life disability UK alternative assessment of capital’ was included in the appendix and this did reduce our capital slightly, although it is not clear if the calculation will still be included in the Life module. A good start in this effort would be to allow own stress tests in this underwriting module (these are, however, allowed for non-life business).

On a more positive note, I was pleased to find that catastrophe risk in the Life underwriting module has now reduced considerably from QIS3 assessment, although the previous assessment from QIS3 is now the QIS4 simplification method—needless to say, we have not used the simplification option! Generally speaking, although a player the size of Unum will have the resources to develop and use its own internal models for risk assessment, there is a concern that current standard approach being proposed is not favouring smaller, specialist insurers.

I read with interest Peter Skinner’s article on the progress of discussions of his report on the draft framework and noted the political interest around the issue of group supervision and this is an area in which QIS4 has looked to flesh out previous thinking. I was, however, disappointed to find that the latest rules provide no guidance for assessing adequate capital requirements for Group risk business. The methods and formulae noted in the specification do not define the necessary assessments for Group business, whereas for ICA we have set our own basis of calculations which allows for the intricacies of Group vs. Individual business.

On another note, we have not included any management decisions in assessing the SCR as this does not appear to be allowed, whereas we include management decisions in relation to increased premiums following adverse experience in the ICA. While there is obvious need for the calculation to be squarely based on financial information for each insurer, management issues that take into considerations the different business cultures of insurers should have a place in deciding how much capital a company is deemed to need to hold.

Operational risk does not allow for individual companies risk mitigation processes. SCR operational risk is not correlated with any risk and is based on a percentage of earned premium and reserves.

Generally speaking the QIS results show that while there is no need for Unum to provide additional capital, Excess Assets are reduced due to increased Technical Provisions offset by lower Solvency Capital (when compared to ICA). Certainly there is still a way to go to achieve a capital requirements regime for insurers which is more streamlined and I look forward to hearing how thinking has moved on, particularly around module boundaries and SCR. QIS4 does appear to be a step closer to the final rules than QIS3, but there still appear to be many issues which need to be finally resolved before 2012. Looking further ahead, we would expect that a QIS5, even if for only part of the full assessment, will be required and perhaps even more ahead of the transposition deadline in 2012. Ultimately this is a huge change to solvency legislation in the EU and will require many man hours to both work towards the deadline to have all required changes to systems in place for the new calculations and also to the changes required for regulatory reporting, including more disclosure requirements.

Jacquie Curness is Chief Actuary at Unum and can be contacted here.