Analysis and opinion

CEIOPS releases latest wave of consultation papers

Background
CEIOPS (the Committee of European Insurance and Occupational Pensions Supervisors) is the body charged by the European Commission to advise it on implementing measures required for Solvency II. Its 2009 timetable includes three rounds of consultations on various aspects of the Directive.

The latest set of consultation papers, released at the beginning of July, tip the scales at over 1000 pages in total. Interested parties have until 4pm CET on 11 September to make comments on any or all of the papers that are listed at the end of this briefing.

Evaluating content
All of the papers can be accessed at http://www.ceiops.eu/content/view/14/18/  For an overview of all the papers, we suggest you scan the executive summary or ‘blue’ section of each.

In its cover letter accompanying release of the consultation papers, CEIOPS specifically invites feedback on aspects of specific papers. For EMB’s part, we have picked out selected papers on which to comment and will be adding to this commentary over the coming weeks.

Group internal models (CP37 addendum)
The addendum to consultation paper 37 illuminates some of the thinking about group internal models in light of the compromise reached on group supervision in the final wording of the Solvency II Directive.

• The approach to a group model will have to be consistent with that used for solo entities. This also applies to the pre-application process. Companies will also have to take into account the need for country supervisory authorities to develop cross-border work and communications plans
• An application pack will need to be produced and signed off by the relevant regulatory body. This will have to be submitted in an approved language of the Group’s member state. However, if requested, the Group would be responsible for providing a translated version to any other country supervisor
• Individual business units could be able to be excluded from group models but the rationale would have to be explained. Subsequent additions of business units to the model will require separate approval and the supervisor may also be at liberty to request a transitional plan for the inclusion of any excluded entities.

Data quality (CP43)
The paper refers to data in the context of technical provisions but points out that a consistent approach to the use of data within an entity is a requirement of all aspects of Solvency II

• Organisations should have procedures in place for ensuring the completeness, appropriateness and accuracy of data used in their valuations, taking into account the proportionality principle within Solvency II
• CEIOPS defines its view of completeness, appropriateness and accuracy
• Internal data gathering and management processes may need to be enhanced where they are found to be lacking

Market risk (CP47)
This consultation paper provides advice on the design and structure of the market risk module of the SCR standard formula, covering interest rate risk, spread risk, currency risk, property risk and concentration risk sub-modules. The QIS4 process showed market risk to be one of the elements of the SCR that was giving companies most cause for concern.  CEIOPS has proposed adjustments to the currency, spread and concentration risk modules.

Consultation on the equity risk module has been deferred until the October/November consultation period.

Non-life underwriting risk (CP48)
EMB is encouraged by CEIOPS’ response to feedback from insurers during the QIS4 process. Recommendations that have evolved as a result include:

• Geographic diversification will not be applied, but will be subject to an impact assessment by CEIOPS as part of the implementing measures
• CEIOPS proposes to introduce a new element for risks relating to premium provisions for multi-year insurance contracts
• CEIOPS recognises the complexity of the standard formula in this whole area and recommends that those with detailed risk mitigation measures consider at least a partial internal model
• CEIOPS intends to consult further with the industry to develop standard scenarios for calculation of catastrophe risk. These standardised scenarios should be developed by June 2010 in time for QIS5
• Premium and reserve risk need to be calculated for each line of business undertaken

Operational risk (CP53)
During QIS4, measures of operational risk using the standard formula were generally lower than those calculated with an internal model. CEIOPS appears to have come to the view that this implied the standard formula didn’t fully take into account the true picture of operational risk facing businesses.

It proposes several revisions, with some structural changes and a large number of the parameters being roughly doubled.

Internal model approval (CP56)
At more than 200 pages in its own right, there is a lot of ground to cover here and our observations are based on an initial review.

• CEIOPS is recommending a series of principles on which to base a decision as to whether a company’s internal models meet the ‘use test’. These are based on a foundation principle: “the undertaking’s use of the internal model shall be sufficiently material to result in pressure to improve the quality of the internal model.”
• CEIOPS has set out governance requirements for the management body and the risk management function with what it regards as appropriate feedback mechanisms and relevant responsibilities
• Companies would be required to be able to justify the assumptions in their internal model to the supervisory body at any time. These assumptions and methods would need to be consistent throughout groups.
• CEIOPS will instigate an impact assessment for the use of data focused around four options with varying levels of supervisory involvement
• Expert judgement within models would be subject to strict requirements
• CEIOPS recommends that supervisory authorities may require organisations to run their internal model on relevant benchmark portfolios or using external assumptions whenever they have concerns about the calibration of the internal model and the adequacy of its specification
• Organisations would be required to regularly back-test their internal models, including retrospective assessments of expert judgement
• CEIOPS outlines in detail its proposed requirements for documentation of the internal model covering specification, development and failures
• Firms would be able to use different time horizon and risk measures to those used in the standard formula providing that they demonstrate an equivalent level of protection to policy holders
• Documentation standards are less onerous than feared but still imply a significant amount of work

College of Supervisors (CP62)
As part of the rethink required to group supervision as a result of the finally agreed text of the Directive, CEIOPS explains the proposed role for the College of Supervisors. The paper covers membership and participation as well as the arrangements to be implemented in crisis situations.

The broad aims of the College are summarised as: It will aim at facilitating exchange of information, views and assessments among supervisors in order to allow for a more efficient and effective group and solo supervision and timely action. The College of Supervisors will enable supervisors to develop a common understanding of the risk profile of the group as the starting point for a risk based supervision at both group and solo levels.”

Notable absence
A notable absentee from the list of consultation papers in this round is advice relating to the use of partial internal models. We believe this will be an attractive route for certain organisations as it leaves some of the components of the standard formula intact in its original form while also using an internal quantification tool.

A key function of the partial model is to allow firms with limited resources to model what they can to integrate into the standard formula, and thus have an SCR better tailored to their risk profile. The methodology for integrating partial model results is still a key open question.  The standards for gaining approval for the partially modelled components are, in the Directive wording at least, essentially the same as for a full model.

CEIOPS has advised that its advice paper on this subject will be published in October/November.

Full list of consultation papers
CP37 – Addendum to draft Level 2 advice on the procedure for approval of a group internal model
CP39 – Draft Level 2 advice on technical provisions – Best Estimate
CP40 – Draft Level 2 advice on technical provisions – Risk free interest rate
CP41 – Draft Level 2 advice on technical provisions – Calculation as a whole
CP42 – Draft Level 2 advice – Risk margin
CP43 – Draft Level 2 advice on technical provisions – Standards for data quality
CP44 – Draft Level 2 advice on technical provisions – Counterparty default adjustment
CP45 – Draft Level 2 advice on technical provisions – Simplifications
CP46 – Draft Level 2 advice on own funds – Classification and eligibility
CP47 – Draft Level 2 advice on the SCR Standard Formula – Market risk
CP48 – Draft Level 2 advice on the SCR Standard Formula – Non-life underwriting risk
CP49 – Draft Level 2 advice on the SCR Standard Formula – Life underwriting risk
CP50 – Draft Level 2 advice on the SCR Standard Formula – Health underwriting risk
CP51 – Draft Level 2 advice on the SCR Standard Formula – Counterparty default risk
CP52 – Draft Level 2 advice on the SCR Standard Formula – Reinsurance mitigation
CP53 – Draft Level 2 advice on the SCR Standard Formula – Operational risk
CP54 – Draft Level 2 advice on the SCR Standard Formula- loss absorbing capacity of technical provisions
CP55 – Draft Level 2 advice on the SCR Standard Formula – Minimum capital ratio calculation
CP56 – Draft Level 2 advice on tests and standards for Internal Model approval
CP57 – Draft Level 2 advice on capital add-on
CP58 – Draft Level 2 advice on supervisory reporting and disclosure
CP59 – Draft Level 2 advice on remuneration
CP60 – Draft Level 2 advice on group solvency assessment
CP61 – Draft Level 2 advice on intra-group transactions and risk concentration
CP62 – Draft Level 2 advice on cooperation and colleges of supervisors

All of the papers can be accessed at http://www.ceiops.eu/content/view/14/18/  Otherwise, EMB will be publishing a briefing paper on the key points in the very near future.