Factsheet Solvency II - Final - English - tcm47-335167

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Solvency II

A new framework for prudential supervision of


insurance companies

Solvency II implemented on 1 January 2016.


1 January 2016 marks the introduction of Solvency II, a new introduction of risk-based capital requirements and the
framework for the prudential supervision of insurers. This mark-to-market approach for balance sheet items. Although
is a huge step forward for insurance supervision. Solvency the new framework still does not provide comprehensive
II is the product of a prolonged international negotiation guarantees, it helps insurers and supervisors identify risks at
process. The new supervisory framework comprises an earlier stage and take action where needed. Furthermore,
European rules on the taking-up and pursuit of the Solvency II strengthens insurers’ risk management and
business of insurance and reinsurance, the supervision of introduces further harmonisation at the European level,
insurance and reinsurance groups, and the reorganisation thereby promoting a level playing field, which is a step
and winding-up of insurance companies. Its purpose is to towards creating a more European market.
protect policyholders. Key principles in Solvency II are the

Why replace Solvency I?


The existing Solvency I framework dates from the 1970s the risk sensitivity of that position, which left it uncertain
and is in urgent need of replacement. The key downside to whether they would be able to meet their commitments.
Solvency I was that it did not tailor capital requirements In addition, from a European perspective the framework did
to the actual risks that insurance companies are exposed not afford clear and uniform policyholder protection, did not
to, providing insufficient incentives for responsible risk allow for adequate harmonisation of supervision across
management. Solvency I also did not allow for acquiring full Europe, and provided only limited supervision at group level.
transparency on the current financial position of insurers nor

To which insurance companies does the new


framework apply?
Solvency II, the new supervisory framework harmonised at a national level. This regime is built up along the lines
at a European level, applies to medium-sized and large of Solvency II, but is less extensive in scope, in view of
insurance companies. Small insurance companies and
1
proportionality. In practice, this means that the Basic
funeral expenses and benefits in kind insurers are subject framework has been adjusted to make the requirements
to Solvency II Basic, a simplified supervisory framework easier and simpler for small insurance companies to comply

1 Medium-sized and large insurance companies are those whose gross premium income
exceeds EUR 5 million and/or whose technical provisions exceed EUR 25 million and/or whose
reinsurance activities and/or activities abroad are non-negligible.
with. The smallest insurers – with premium income and Insurance companies may voluntarily choose to subject
technical provisions not exceeding EUR 2 million and themselves to a stricter supervisory framework: exempt
EUR 10 million, respectively, and whose maximum sum insurers may opt for Solvency II Basic and insurers governed
insured is EUR 12,500 – are exempt from DNB’s supervision. by Solvency II Basic may opt for Solvency II.

How is Solvency II structured?


Groups
Supervisory review process
Collaboration between supervisory authorithies

Pillar 1 Pillar 2 Pillar 3


Risk quantification Risk management Transparency

▪ Mark-to-market balance ▪ Governance requirements ▪ Report to the supervisor


sheet valuation ▪ Own Risk and Solvency ▪ Public disclosure
▪ Solvency capital Assesment (ORSA) ▪ Accountability
requirement (SCR)
▪ Minimum capital
requirement (MCR)

Solvency II is based on three pillars, setting out risk Pillar 2 concerns the governance of insurance companies.
quantification, governance and transparency requirements. In concrete terms, an effective system of governance
includes four key functions: risk management, compliance,
Pillar 1 contains quantitative requirements, including markt- actuarial, and internal audit. This pillar also imposes fit and
to-market balance sheet valuation and quantification of proper requirements on directors, managers, and holders of
market risks and insurance technical risks. Insurers must these key functions. In addition, insurers themselves must
value their balance sheet items based on current market review their policies, strategy and risk appetite on a regular
prices and measure their risks using either a standard basis in an own risk and solvency assessment (ORSA) and
formula or an internal model. These two methodologies report their findings to DNB.
serve to calculate the buffer they must maintain.
The standard formula is the risk measurement 1 Medium- Pillar 3 safeguards transparency by means of the
sized and large insurance companies are those whose gross solvency and financial condition report (SFCR), which is
premium income exceeds EUR 5 million and/or whose public, and the regular supervisory report (RSR), which
technical provisions exceed EUR 25 million and/or whose is confidential. The public report is published annually
reinsurance activities and/or activities abroad are non- and contains information about an insurer’s activities
negligible. methodology established at European level. and results, operations, risk profile, the principles used to
Insurers must be able to demonstrate that the standard value its assets, technical provisions and other liabilities,
formula is suitable for them. If the standard formula does and capital management. Insurers are also required to
not match their specific risks, they must use a full or partial publish quantitative reporting forms, which constitute the
internal model or company-specific parameters. These confidential report, together with a descriptive section. This
internal models must be drawn up by the companies descriptive section is identical to the public report in terms
themselves and approved by DNB. of structure but contains additional, confidential supervisory
information. The confidential report also comprises as a whole. Another overarching element of the Solvency II
the ORSA of pillar 2. In addition to these three pillars, framework is the supervisory review process (SRP), which
Solvency II elaborates on three key themes: improving group defines the reviews, evaluations and assessments to be
supervision, the supervisory review process, and cooperation conducted by the European supervisory authorities. Lastly,
between supervisory authorities. Group supervision will the new framework harmonised at a European level should
be substantially enhanced under Solvency II. In practice, encourage international collaboration between supervisory
this means that supervision will be exercised not only on authorities within the European Insurance and Occupational
individual insurers as part of a group but also on the group Pensions Authority (EIOPA).

How to interpret and calculate solvency ratios


under Solvency II?
It is essential to fully and accurately grasp the Solvency it will still be able to meet its obligations in the event of a
II ratio before issuing an opinion on an insurer’s financial severe shock that is expected to occur once in every 200
position. This is because a solvency ratio of 100% under years. The target confidence level for insurers has been set
Solvency II is something altogether different from a solvency at 99.5% over a one-year horizon.
ratio of 100% under Solvency I, due to differences between
the calculation methodologies underlying the two ratios. Assets Liabilities
Unlike Solvency I, Solvency II takes account of the actual Excess
own funds
risks that insurers assume in calculating their solvency
capital requirements. Under Solvency II, the solvency ratio is
Own
the ratio of eligible own funds to required own funds. funds
SCR
Own funds MCR
Solvency ratio =
Solvency capital requirement (SCR)

Required own funds, also referred to as the solvency capital
requirement (SCR), constitute a risk-based buffer, based
on the actual risks on the balance sheet. This means that
insurers with higher-risk investments, such as equities, must
Technical provisions
maintain a higher buffer than those investing in lower-risk
assets, such as government bonds. In addition to the SCR,
Solvency II applies the minimum capital requirement (MCR),
also referred to as minimum required own funds. A Solvency
II ratio of 100% means that an insurer’s capital is such that

What is DNB’s objective for Solvency II ratios?


The statutory supervisory standard under Solvency II is and avoid having to prepare a recovery plan immediately
100%, including ultimate forward rate (UFR) and other following adverse events. DNB welcomes these practices.
adjustments. Insurers failing to comply will face formal Solvency II does more justice to an insurer’s actual risk
recovery actions imposed by DNB. In addition, insurers profile, which is why DNB expects many companies to
are setting internal standards above 100%, for example to use target solvency ratios that are closer to the statutory
ensure continuous compliance with the statutory standard supervisory standard, compared with Solvency I.
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Why impose capital requirements and buffers on


insurance companies and how do they work?
Buffers protect institutions against significant changes in required to maintain that confidence level. Insurers whose
the financial markets and insurance risks, and help them buffers are dwindling can take specific actions to restore
meet their future obligations even in the event of setbacks. them to the required level, including raising capital, reducing
The targeted confidence level for insurers is 99.5% over a dividend payments and lowering their risk profiles.
one-year horizon. The larger the risks, the higher the buffer

When does DNB intervene?


The new Solvency II framework provides several options for funds drop below the MCR, DNB may appoint a secret
intervention. One of them is requiring insurers to submit receiver, impose a production stop or revoke the insurer’s
a recovery plan if they fail to comply with the solvency authorisation. DNB may also transfer insurance portfolios
requirement because their eligible own funds drop below and adjust the policy conditions if it sees fit. Lastly, DNB may
the SCR. Such recovery plans, subject to DNB’s assessment issue an instruction in the event of shortcomings in terms of
and approval, should help these companies meet the governance.
requirement again within six months. If an insurer’s own

What does Solvency II imply for insurers’


dividend policies?
Insurance companies are responsible for their own dividend pay attention to this in their ORSA. Where needed, DNB will
policies as part of their overall capital policies. DNB believes consider the UFR impact in assessing an insurer’s capital
that insurers would do well to take account of the impact of and dividend policies. Insurance companies have a statutory
the UFR – which forms part of the actuarial interest rate – obligation to seek DNB’s approval before distributing
and other adjustments. In the context of adequate risk dividends if they fail to meet their solvency requirements or
management under Solvency II, insurers are also expected to foresee noncompliance within the next twelve months.

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When will the first figures and reports under


Solvency II be published?
Insurance companies will be preparing both public and after the end of the 2016 financial year. Group reports must
confidential reports under Solvency II. The first public be submitted within 26 weeks after the end of the 2016
Solvency II reports will concern the 2016 financial year. financial year. Insurers are free to publish Solvency II figures
These reports must be publicly disclosed within 20 weeks before then, as some listed companies are already doing.
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To what extent are Solvency II figures and


reports comparable across the EU?
A number of transitional measures have been designed II. Some other European companies are making use of the
to facilitate the changeover to Solvency II, most of which transitional rules on a larger scale, however. This means
may be applied during the next 16 years. All other things that for the time being it will be difficult to compare the
being equal, companies using these measures will have Solvency II figures of Dutch insurers with those of their
higher solvency ratios, which must be kept in mind when counterparts elsewhere in the European Union. The effects
comparing insurance providers in various countries. Dutch of the transition regime will be visible from the reports that
insurance companies are wellprepared for Solvency II, insurers must publish from 2017 onwards, which will make it
making little or no use of the transitional regime. As a result, easier to compare insurance providers across the European
the Netherlands applies a relatively “pure” variant of Solvency Union.

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How does the current low level of interest


rates affect insurers?
The effect of low interest rates on insurance companies is to Solvency II, the calculation method will not be changed
only partially reflected in their financial reports, due to the before the end of 2016. The gap between the fixed UFR and
use of the UFR in the supervisory framework. Under the market interest rates is therefore expected to persist for the
UFR calculation method, the yield curve used to discount time being. This may lead to excessively high expectations
liabilities with maturities exceeding 20 years converges among policyholders, unrealistic promises to policyholders
towards a fixed level. This is because there are relatively and distorted incentives at institutions. The UFR impact on
few products with similar long maturities available in the Dutch life insurance companies may be high by comparison
financial markets, which makes the related interest rates with many other European countries because, on average,
less reliable and more difficult to estimate. The UFR also they have longer-term liabilities. DNB emphasises that
contributes to the stability of the solvency calculation. insurers should be aware of this, taking it into consideration
The gap between the fixed UFR and the current level of in their risk management and capital policies. This will allow
long-term interest rates has grown steadily over the past them to, for instance, perform an analysis of measures
few years, however. EIOPA has announced that it will review (e.g. to lower their risk profile) when facing a deficit in the
the UFR methodology in 2016. To ensure a smooth transition absence of the UFR impact.

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