05 May 2010
Published in: Regulation - supervision
QIS5 draft breathes new life into Solvency II principles
CEIOPS' advice threatened the very consistency that the European Commission is seeking to achieve with Solvency II, says one of the respondents to our questions on the EC's draft QIS5 technical specifications.
When the technical specifications for the draft fifth quantitative impact study (QIS5) were issued on 15 April, they were a relief to large sections of the insurance industry. But many issues still have to be decided. And the picture could yet change again before implementation of Solvency II.
What in particular pleased insurers and what else do they think the EC should be looking at?
We asked eight experts for their views. We're publishing their answers to the first question this week. Responses to the second question will be published next week.
The respondents:
Charl Cronje, partner, Lane Clark & Peacock
David Dullaway, partner, Oliver Wyman
Charles Garnsworthy, partner, PwC
John Hume, CFO, XL Re
Teddy Nyahasha, group solvency director, Aviva
David Paul, director, Ernst & Young's European actuarial services practice
Bruce Porteous, head of UK risk capital development, Standard Life
Margarita von Tautphoeus, head of Solvency II Consulting, Munich Re
The question:
What will most please the insurance industry in the European Commission's draft QIS5 technical specifications?
The responses:
David Paul, director, Ernst & Young's European actuarial services practice
The EC has now acknowledged and started to address the concern caused by Committee of European Insurance and Occupational Pensions Supervisors (CEIOPS)' 2009 final advice. General insurers are relieved that the EC has not adopted CEIOPS' recommended calibrations for the non-life capital requirements in the premium risk and reserving risk modules of the standard formula solvency capital requirement (SCR).
In addition, the EC has re-inserted into QIS5 a methodology that recognizes capital savings that are the result of geographical diversification. This is particularly important for many London market and Lloyd's operations carrying diverse product lines with wide or global reach.
Teddy Nyahasha, group solvency director, Aviva
The industry considers that the EC's draft QIS 5 specifications represent an important step towards the development of the economic risk-based solvency framework promoted by Solvency II.
The classification of the excess of assets over liabilities including in-force cash-flows (or expected future profits) in the tier 1 own funds [see also IERM, 20 April 2010, "Include expected future profits in tier 1 capital"] and the recognition of liquidity premiums and diversification between business lines in the risk margin are particular examples where the EC has moved to reinforce the economic approach and remove provisions that are inconsistent with the objectives of Solvency II.
Teddy Nyahasha: "The EC has moved to reinforce the economic approach and remove provisions that are inconsistent with the objectives of Solvency II."
John Hume, CFO, XL Re
There is evidence that the views of the European industry are being listened to. This is crucial if we are to avoid putting the health of the European insurance market at risk through the imposition of solvency requirements at a level that would create an uneven global competitive landscape. The original intention and proposals of the Solvency II regime were to ensure a level of consistency across the European market and a standard that understood that there would be residual "risk of ruin". Some of the recent proposals have set the bar far higher than the original proposals and, as such, put at risk the very consistency that the EC is seeking to achieve.
The parameters for QIS 5 have been adjusted in response to certain industry concerns about particular lines of business and have also allowed for geographic diversification.
The proof, though, will be in the actual running of QIS 5. Furthermore, the adjustments still do not make up for the fact that there is a cost associated with the mapping of the lines of business in an organization to the Solvency II lines of business.
Bruce Porteous, head of UK risk capital development, Standard Life
I believe that the industry will be very pleased that the EC appears to have accepted the industry's arguments on many of the most contentious aspects of CEIOPS' final advice. Examples include: own funds issues, the illiquidity premium, risk margin diversification and SCR calibration. The own funds aspects, expected future profits being treated as tier 1 capital and the proposed grandfathering rules are especially helpful.
David Dullaway: "There needs to be a balance; it's no good for consumers to have very strong insurance companies that can't afford to write any business."
David Dullaway, partner, Oliver Wyman
There is actually quite a lot to be pleased about in the draft QIS5 specifications. Three things I'd pick out specifically are the general weakening of the more extreme suggestions CEIOPS had made in respect of individual stresses and correlations, the more sensible treatment of so-called '"future profits" in the tiering of own funds and, from a UK industry perspective, the inclusion of a liquidity premium in the valuation of liabilities. More generally, the industry will be most pleased by the strong stance the EC is taking in reining back CEIOPS.
It was always going to be hard to introduce a rigorous 1:200 capital requirement in the face of a lack of good data and in the aftermath of a global financial crash, and at the same time arrive at a system which had no material impact on the aggregate level of capital the insurance industry requires. CEIOPS was always likely to focus more on the need for protection than on avoiding the need for large-scale capital raising -- as regulators that is the focus they are meant to take. But there needs to be a balance; it's no good for consumers to have very strong insurance companies that can't afford to write any business. The EC is clearly taking a more balanced view.
Bruce Porteous: "The own funds aspects, expected future profits being treated as tier 1 capital and the proposed grandfathering rules are especially helpful."
Charles Garnsworthy, partner, PwC
That the EC has responded to the industry concerns by significantly reducing the required capital for QIS5 compared to CEIOPS' proposals is in itself a win for the industry. The downward reductions in the calibration of the certain risk categories including the non-life premium and reserve risks have been very welcome.
Indeed, the proposals on the illiquidity premium provide significant relief. Single premium retirement annuities in payments appear to benefit from a full illiquidity premium and transitional provisions permitting the use of the expected asset-based discount rate if sold before the implementation of Solvency II.
The inclusion of an illiquidity premium is not restricted to single premium retirement annuities; all other contracts with a term of greater than or equal to one year will benefit from 50% of the market-observed illiquidity premium. This could be somewhat generous and conversely harsh on certain products.
Furthermore, there have been significant changes to own funds. Particularly important are the reclassification of future profits and the winding-up gap as eligible for treatment as the higher quality tier 1 rather than the more restricted tier 3 capital.
Charles Garnsworthy: "That the EC has responded to the industry concerns by significantly reducing the required capital for QIS5 compared to CEIOPS' proposals is in itself a win for the industry."
Charl Cronje, partner, Lane Clark & Peacock
We should be encouraged by the overall response of the EC. The draft QIS5 specification recognizes a whole range of issues on which the industry has lobbied. A good example is the reintroduction of geographic diversification after lobbying from Lloyd's in particular. This will be welcomed by many insurers.
Margarita von Tautphoeus, head of Solvency II Consulting, Munich Re
The EC's draft for QIS5 appears more realistic in a sense that the risk calibration is still more conservative than QIS4 but less overstated than consultation paper (CP) 71 and CEIOPS' final advice. The insurance industry will especially appreciate two factors: company specific data is taken into account on an improved basis and an industry proposal for a more adequate measurement of the effect of non-proportional reinsurance has been integrated.