A Critical Perspective on the Solvency II Implementation · 2016-07-04 · Solvency II went live...

A Critical Perspective

on the Solvency II

Implementation

Dr. Dieter Wemmer

ICIR | Goethe University

Frankfurt, 28 June 2016

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2016 2017 2018 2019 2020 2021

ICS

consultation

BCR and HLA refinement / reporting

ICS v1.0 Adoption of ICS v2.0 replacing BCR

Application of HLA

Solvency II went live this year but the evolution of

regulatory frameworks will continue

Solvency II

application

Solvency II

development

Recent

comments by

supervisors

Review of standard formula

Planned further development of international capital requirements (by EU and IAIS, respectively)

International

capital

developments

ICS v2.0

consultation

Solvency II

application

Review of LTG

measures

“Solvency II is too

complex and volatile”

“The future review of Solvency II

should take into account the progress

achieved at an international level”

“Solvency II to shape the ICS and let

Solvency II be shaped by the ICS”

IAIS = International Association of Insurance Supervisors LTG = Long Term Guarantee ICS = Insurance Capital Standard

BCR = Basic Capital Requirement HLA = Higher Loss Absorbency

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A Critical Perspective on the Solvency II Implementation

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INTERPRETATION RISK MANAGMENT

REPORTING AUDIT

Inconsistent interpretation of key

elements of Solvency II

Sovereign Risk

Volatility Adjustment

Solvency Capital Requirement

Interference of national accounting

with Solvency II and divergent

stress testing approaches

Challenging effective risk management

Cross-sectoral divergence in stress testing

Scope ranges from complete waiver

to comprehensive audit requirements

Considerable variation in

external audit requirements

Insurers are currently facing inconsistent Solvency II

implementation throughout Europe

National specific reporting templates

Narrative reporting requirements

Substantial additional local

reporting requirements

beyond Solvency II scope


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Inconsistent interpretation of key elements of

Solvency II results in an un-level playing field

Solvency

Capital

Requirement

Key topics Issue Implications

Sovereign

Risk

Volatility

Adjustment

For jurisdictions which only allow a

“static” Volatility Adjustment:

Limitation of volatility mitigation

Inconsistency between valuation and risk capital calculation

Different approaches for granting the

Volatility Adjustment within Internal Models.

Legislation requiring consistency in valuation and risk capital

calculation.

The role of the MCR as genuine

minimum capital requirement is not acknowledged.

Expectations for Solvency II SCR

ratios seem to be driven by Solvency I based experience.

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MCR = Minimum Capital Requirement SCR = Solvency Capital Requirement

For Internal Models no consistent

treatment of sovereign credit risk throughout Europe.

Different approaches within the

Allianz Group Internal Model required, depending on location of the subsidiary.

Un-level playing field between

Internal Model companies.

INTERPRETATION INTERPRETATION

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Market Value Balance Sheet (Solvency II) Local Accounting Balance Sheet (HGB)

Objective:

Policyholder protection

Dividend payment capacity

Trigger of supervisory action

Valuation approach: market value

Use of current market values and market parameters (interest rates) adjusted to

cater for the long-term nature of (life) insurance business

Best estimate of liabilities

Solvency assessment: capital requirements

based on worst case scenario changes in own funds (1-in-200 year loss)

Objective:

Measurement of annual profit

Dividend payment capacity

Trigger of insolvency actions (in some countries, including Germany)

Valuation approach: book value

Asset valuation based on cost value

Liability valuation based on present value

of liabilities discounted with fixed interest rate

Conservative estimation of liabilities and provisions for adverse deviations

Solvency assessment: positive net asset

value at valuation date

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HGB = Handelsgesetzbuch (German Commercial Code)

RISK

MANAGEMENT Interference of national accounting with Solvency II

challenges effective risk management

Inconsistent valuation framework and different solvency assessment approach lead to

diverging capital perspectives which challenge effective risk management

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1,000

50

1,000

50

Asset Liability

Asset Cash Liability NAV/OF

1,000

50

1,000

50

Asset Liability


In principle, different valuation approaches result in

different perspectives on capital

HGB

Balance Sheet Market Value

Balance Sheet

The liability is discounted at the

guaranteed rate of 0%.

The asset is valued at

acquisition cost.

Net Asset Value is held in cash.

Best estimate value of the

liability is determined using the

risk-free rate of 0%.

The asset is held at market

value.

Net Asset Value is held in cash.

Single premium product

due after 10 years providing a guaranteed interest rate of 0% p.a.

Premium received of 1,000 is invested in risk-free

10 year zero bond at a current market yield of 0% (full asset-liability

match).

Note: since the liability is

perfectly matched, there is no interest rate risk or credit risk, resulting in zero

Solvency II capital requirement in this

example.

Starting Point Base case in year 1

6 NAV = Net Asset Value OF = Ow n Funds


RISK

MANAGEMENT

As guaranteed rate and market rate are equal in the base case,

Solvency II and HGB are identical as well.

EXAMPLE

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< 0 % < -0.4 %

DE 70.8% 48.5%

FR 58.5% 26.8%

IT 25.6% 1.9%

ES 25.1% 2.9%

NL 61.4% 37.9%

BE 48.7% 22.7%

AT 58.2% 21.6%

PT 3.7% 0.0%

FI 52.9% 24.4%

IE 38.7% 0.0%

SK 35.8% 0.0%

SL 15.3% 0.0%

GR 0.0% 0.0%

LI 11.5% 0.0%

LT 37.6% 0.0%

LU 81.2% 0.0%

CY 0.0% 0.0%

MT 0.0% 0.0%

Eurozone 45.2% 19.7%

Market volume of outstanding public debt* with negative yields and yields below the ECB’s deposit rate (EUR bn)

Over 70% of German

public debt with

negative interest rates


*) excluding agencies, excluding T-Bills, including inflation-linked bonds **) including EVB and EIB holdings of GGBs

Sources: Bloomberg, Allianz GI Global Capital Markets & Thematic Research. Data as of 20 May 2016

Risk management needs to consider that ultra low

interest rates may not continue forever

RISK

MANAGEMENT

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942

50

1,000

8

Asset Liability


942

50

942

50

Asset Liability


HGB

Balance Sheet Market Value

Balance Sheet

NAV = Net Asset Value OF = Ow n Funds

Assuming four years of rate

increases…

0,0%

0,2%

0,4%

0,6%

0,8%

1,0%

1,2%

1 2 3 4 5 6 7 8 9 10

Increased rates lead to write-

downs on assets (due to

“Niederstwertprinzip”) while

liabilities remain unchanged

resulting in accounting losses

and insolvency.

Increased rates lead to lower

asset values and equally lower

liability values.

…results in insolvency under

HGB (negative NAV) while the entity is still well capitalized under Solvency II (as

economically reasonable) and all policyholder promises can be

fulfilled.

Development and implications Solvency situation in year 4

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Rising interest rates trigger default under local

accounting in contrast to Solvency II

RISK

MANAGEMENT

EXAMPLE

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-20

-10

0

10

20

30

40

50

60

70

0 1 2 3 4 5 6 7 8 9 10

Net Asset Value (HGB, ZZR)

Net Asset Value (HGB w/o ZZR)

Own Funds (Solvency II)

At maturity of the

contract the policyholder is paid out, the

insurer is solvent and has the same

capital under HGB and Solvency II.

Although being

insolvent under HGB earlier, the

net asset value of the insurer recovers towards

maturity of the contract.

The additional

interest rate reserve further accelerates capital

depletion under HGB.

Those additional reserves (e.g., ZZR in Germany) are

designed to provide an additional safety

margin and reflect the gap between guaranteed rate and

historic average yield.

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Year

CU

CU = Currency Unit ZZR = Zinszusatzreserve (additional interest reserve under German law )


Local accounting framework requires more capital than Solvency II in order to avoid interim default.

RISK

MANAGEMENT Additional interest rate reserves are a meaningful tool

but could accelerate the default

EXAMPLE

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Harmonization of local accounting regimes with Solvency II is a prerequisite for effective

risk and capital management.

Local

Accounting Solvency II Implications Country examples

Equalization

reserve

Required

capital (SCR)

Inconsistent approach to provide a buffer

for deviations from expected payouts.

Germany, Austria,

Portugal, Spain, Belgium, Italy

Specific

technical reserves (e.g., for adverse

deviations)

Best Estimate

cash flow projections

Local reserving requirements drive

Solvency II liabilities away from the best estimate approach and distort Solvency ratios.

Romania, Portugal,

Spain, Belgium, Italy

Further local

constraints

Economic

perspective on solvency

Further local reserve assessments

limiting dividend payments “Sicherungsvermögen” (restricted assets

under German law)

Germany, Belgium


RISK

MANAGEMENT Inconsistencies of local accounting rules with

Solvency II provide additional challenges

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Divergent stress test approaches between insurance

and banking

Insurance sector double-hit

scenario 2016 Banking sector adverse macro-financial scenario

Shocks to EURO-SWAP rates

Maturity 1 2 3 5 7 10 20 1 2 3 5 7 10 20 30

(bp) -60 -65 -77 -71 -61 -61 -61 2016 44 47 55 55 58 54 51 47

2017 45 40 53 49 55 48 48 41

2018 27 19 29 24 30 24 26 20

Implied shock to credit spreads (German 10-year sovereign bond)

2016 2016 2017 2018

(bp) 153 17 32 44

Shocks to stock prices

2016 2016 2017 2018

(%) -33.4 -25.4 -24.7 -16.4

Shocks to residential property prices in EU

2016 2016 2017 2018

(%) -6.7 -11.6 -7.4 -4.9

Source: “EIOPA Stress Test 2016 Technical specifications” and “Adverse macro-financial scenario for the EBA 2016 EU-wide bank stress testing exercise”

Moderate interest rate

up scenario

Insurance and banking stress tests appear economically inconsistent and placing a

higher onus on insurers. This may result in inadvertent loss of public confidence in insurers.

Extreme credit spread stress

Moderate credit

spread scenario

Extreme interest rate down shock

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RISK

MANAGEMENT

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Substantial additional local reporting requirements

beyond already generous Solvency II scope

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National specific reporting templates

France

37 local templates

Submission via XBRL

Starting in 2017

United Kingdom

13 local templates

Initially to be submitted in Excel

Starting in 2017

Ireland

13 local templates

Submission via XBRL

Starting in May 2016

Spain

11 local templates + additional information

in 2 QRTs

Submission via Access based Application

Starting in May 2016

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Narrative reporting requirements

Germany

Widening of qualitative reporting scope

Detailed information on valuation approach and

explanation of valuation differences compared

to Solvency I

Netherlands

Specific audit procedures

Additional templates in report

Ireland

Special analysis of Solvency I closing and

Solvency II opening balance sheet

Greece

External audit report on balance sheet

information within report requested

Spain

Special analysis of Solvency I closing and

Solvency II opening balance sheet

RSR = Regular Supervisory Report SFCR = Solvency and Financial Condition Report XBRL = eXtensible Business Reporting Language

QRTs = Quarterly Reporting Templates

Examples from selected jurisdictions


REPORTING

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SII Audit is still under discussion in: Czech Republic Finland

Ireland (BS/SCR/OF) Italy (BS/SCR/OF)

Malta Norway Portugal (SFCR and QRTs)

Romania (SFCR)

Currently no SII Audit planned in: Croatia Denmark

France Latvia

Slovakia Sweden

No feedback on SII Audit received from: Bulgaria

Estonia Lithuania

Luxemburg Slovenia

UK (under discussion) Public disclosures: Solvency Balance Sheet

SCR/MCR/OF TPs and Risk Margin

LTGs and Transitionals Sections of the SFCR

Greece Solvency Balance Sheet Own Funds

Information of supervisor if SCR/MCR-non-compliance

Belgium QRTs RSR/SFCR

Spain SFCR

Germany Solvency Balance Sheet Information of supervisor if

SCR/MCR-non-compliance

Poland SFCR

Austria Solvency Balance Sheet SCR/MCR/OF

Effectiveness ICS, RM-System and Internal Audit

Hungary Solvency Balance Sheet SCR/MCR/OF

Effectiveness ICS, RM-System and Internal Audit

Cyprus Solvency Balance Sheet SCR/MCR/OF

Netherlands (Day 1) Solvency Balance Sheet SCR/MCR/OF

Internal Controls/Data

BS = Solvency Balance Sheet RM = Risk Management TPs = Technical Provisions

Source: Pw C

Considerable variation in external audit requirements

National audit requirements under Solvency II

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AUDIT

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While the evolution of regulation continues, Solvency II cannot be considered

successfully implemented before fundamental issues are addressed:

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A common interpretation of key Solvency II elements is essential for a

true level playing field in Europe.

Obstacles to effective risk and capital management arising from local

accounting implications need to be removed.

National specific reporting requirements should be abandoned as

incompatible with a single insurance market in Europe.

Audit requirements should be harmonized across Europe to allow for efficient reporting processes.

Summary

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Disclaimer

15

These assessments are, as always, subject to the disclaimer provided below.

Forward-looking statements

The statements contained herein may include prospects, statements of

future expectations and other forward-looking statements that are based

on management's current views and assumptions and involve known and

unknown risks and uncertainties. Actual results, performance or events

may differ materially from those expressed or implied in such forward-

looking statements.

Such deviations may arise due to, without limitation, (i) changes of the

general economic conditions and competitive situation, particularly in the

Allianz Group's core business and core markets, (ii) performance of financial

markets (particularly market volatility, liquidity and credit events) (iii) frequen-

cy and severity of insured loss events, including from natural catastrophes,

and the development of loss expenses, (iv) mortality and morbidity levels and

trends, (v) persistency levels, (vi) particularly in the banking business, the

extent of credit defaults, (vii) interest rate levels, (viii) currency exchange

rates including the Euro/U.S. Dollar exchange rate, (ix) changes in laws and

regulations, including tax regulations, (x) the impact of acquisitions, including

related integration issues, and reorganization measures, and (xi) general

competitive factors, in each case on a local, regional, national and/or global

basis . Many of these factors may be more likely to occur, or more

pronounced, as a result o f terrorist activi ties and thei r consequences.

No duty to update

The company assumes no obligation to update any information or forward-

looking statement contained herein, save for any information required

to be disclosed by law.

A Critical Perspective on the Solvency II Implementation · 2016-07-04 · Solvency II went live...

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Transcript of A Critical Perspective on the Solvency II Implementation · 2016-07-04 · Solvency II went live...