Implications of the introduction of ICAS before SII

Implications of the introduction of ICAS+ before SII Stuart Robinson 1 May 2013

How does ICAS+ fit with other interim approaches? – There is still considerable uncertainty around the actual implementation date for Solvency II … – … but, EIOPA and other local supervisors are keen that companies continue to prepare. – UK is unique in having a Pillar 2 approach (ICAS) with similarities to Solvency II Pillar 1 – ICAS+ presents a framework for closing the gap between ICAS and Solvency II Pillars 1 and 2. – EIOPA are looking to drive regulatory consistency on Solvency II preparations for Pillars 2 and 3 through the interim measures – Therefore, we are expecting: – More focused ICAS reviews under ICAS+, to inform preparation for Solvency II – An opportunity to get more feedback on key elements, including ORSA and embedded use – More structured and intensive engagement with Colleges on Pillar 2 and Solvency II preparations – Alignment of expectations between supervisors – Clarity that there should be limited focus on Pillar 3 until it is clear when Solvency II will be implemented and go live 1

Implications for Pillar 1 Solvency II Internal Model ICA Model Counter-cyclical premium Contract boundaries Model enhancements Ring-fenced funds Equivalence Treatment of non-EEA undertakings Risk calibration methodology Liquidity/Matching premium 1 -year new business treatment Loss-absorbing capacity Diversification Benefit Management actions modelling Pension Schemes Treatment Fungibility requirements Intra-group arrangements Projection to ultimate for GI business Closure of new business risks Group Risk Liquidity Risk Basic risk free rate – There does not appear to be a technical difference between an ICAS and an ICAS+ model – For an ICAS+ model, there should be a proportionate amount of effort on validation and calibration relative to Solvency II, although specific and observable benchmarks will be needed – The delay to Solvency II may also allow an increased proportion of validation and calibration process to be internal. 2

Implications for Pillars 2 and 3 Pillar 2 – For Pillar 2, EIOPA and PRA guidance will require early implementation of many Solvency II based requirements, including: – ORSA type requirements (‘Forward looking assessment of risk’) – Forward looking stress and scenario testing – Embedding of risk appetite in decisions on business strategy – Given the delay to Solvency II, it is reasonable to focus on incrementally refining of BAU processes to address key requirements Pillar 3 – Given the uncertainty on the timing of Solvency II and ultimate Pillar 1 requirements, we expect companies to focus on ensuring that any development effort is cost efficient – The Pillar 3 reporting requirements of Solvency II are clearly still onerous for the industry and early implementation must be avoided until there is greater certainty on timing and Pillar 1 requirements. The EIOPA interim measures take a pragmatic approach to this issue. – A key area of uncertainty is how requirements can be met from a process perspective – key questions include: – How acceptable will a roll-forward approach be? – How accurate do results have to be? – How often will calibrations need to be refreshed? 3

Implications for the Board ICAS+ / Pillar 1 – Under ICAS+, we expect the PRA to look for additional evidence that the Board: – Is aware of the key limitations of the models, data and assumptions – Understands the importance of judgement in the models – Is comfortable that any management actions in the models are appropriate – Is comfortable that the capital requirements for key risks are ‘reasonable’ – Has ensured that Management has established an adequate model control framework Pillar 2 – The introduction of obligations around the ORSA (forward looking assessment of risk under the EIOPA interim measures) will be a key change – We expect to take a pragmatic approach, avoiding duplication of processes and reporting, by leveraging existing management information from: – Plan submissions – Capital and liquidity reports (including forward looking stress & scenario testing) – CRO Reports – However, Boards will still need to be clear that they have met the ORSA requirements 4

Key areas of concern – We see ICAS+ as pragmatic and helpful – We would be concerned if the UK gets too far ahead of the rest of the EU: – No other EU supervisor has an interim approach, so ‘benchmarks’ may be set too high – In addition, the level of effort expected on calibration and validation may ultimately be higher than necessary – On Pillar 2, we are keen to ensure that lessons from the exiting ICA regime are factored into the development of supervisory thinking: – ICA numbers already reflect an economic view of risk and are used to steer the business – An ICA-based ORSA would be a sensible interim option in the UK – Close engagement with EIOPA and other EU supervisors will be essential to ensure that ICAS+ evolves alongside the EIOPA interim measures, to maintain alignment and try to minimise rework as the timetable for Solvency II becomes clearer 5