Solvency II Implications of the New Regulations for

Solvency II Implications of the New Regulations for US – EU Business Offices of Dewey & Le. Boeuf December 5, 2011 Joseph L. Petrelli, ACAS, MAAA, FCA President, Demotech, Inc.

Mission Statement Demotech, Inc. will continue to be the leading provider of innovative solutions to financial analysis issues by focusing our resources on niches presenting opportunity for corporate growth. 2

Joseph L. Petrelli, ACAS, MAAA, FCA President Mr. Petrelli began his insurance career in 1969. Since that date, he has acquired progressively responsible Property and Casualty (P&C) actuarial and financial analysis experience. He has extensive experience with loss and loss adjustment expense reserve evaluation, product development, and pricing for virtually all P&C and Title insurance products as well as expertise with loss cost filings, Financial Stability Ratings® (FSRs) and merger and acquisition valuations. He has been actively engaged in the Title insurance industry since 1992. Prior to founding Demotech, Inc. he was employed by a large national P&C insurer, a regional property and casualty insurer and Insurance Services Office. He is a Member in good standing of the Casualty Actuarial Society, American Academy of Actuaries and the Conference of Consulting Actuaries. Mr. Petrelli has a Bachelors of Actuarial Science from The College of Insurance at St. John’s University and an MBA from The Ohio State University. 3

Serious About Solvency® - Our Perspective Demotech’s business model is to support financially stable insurers that are unrated or underrated by other services. We will not review or follow insurers once we have concluded they have mediocre financial stability. q q q Other rating agencies seem to focus on solvency; yet they seem to weigh the ability to accrue and enhance quarterly earnings heavily. Demotech encourages carriers to focus on long-term solvency. Our perspective encourages carriers to increase loss and loss adjustment expense reserves to adequate as opposed to reasonable levels. Earnings should be stabilized by booking adequate loss and LAE reserves, not manipulated by accruing loss and LAE reserves at an optimistic level. 4

What Is Solvency II? European Union regulation for insurers q Similar to Basel II for banking q Three Pillars q q Capital Requirements for Solvency Governance and Risk Management of Insurers, Regulatory Supervision Disclosure and Transparency Requirements

Timeline April 2009 – European Parliament approves framework q 2009 -2011 – EIOPA (European Insurance and Occupational Pensions Authority), the European regulators, perform quantitative impact and country equivalence studies q November 2011 – EIOPA published a consultation document on reporting requirements under Solvency II. The opportunity to provide feedback or commentary regarding the clarity of Solvency II’s reporting requirements is open until January 20, 2012. q

Timeline (cont. ) October 31, 2012 – Original Effective date of implementation q February 2012 – European Parliament will consider Omnibus II amendments q q q Changes effective dates to January 1, 2013 for supervisors and January 1, 2014 for insurers Adds transitional provisions to allow longer term implementation

Own Risk & Solvency Assessment (ORSA) & Use Test Under Solvency II q All insurers and reinsurers will have to conduct regular ORSAs – a view of the company’s own risk profile and solvency assessment, or capital, needs. q Article 45 of the Solvency II directive requires that all companies perform a regular ORSA and that they provide the company’s regulator with documentation on the process. q “Use test” requires insurers to demonstrate that any internal model of capital requirements is widely used in and plays an important role in governance, risk management, decision making and ORSA

Impediments q Technical standards q q These are under development therefore companies are not sure how to implement Some draft standards are not due until December 2017 – would these require changes to a prior implementation? High costs involved in trying to comply with a moving target Equivalency q q Only Bermuda, Switzerland Japan have regulatory systems deemed equivalent to Solvency II United States system is not yet considered equivalent since it has many state regulators instead of one federal regulator

Impact on Domestic Insurance Companies q Direct q q q Only 196, or 7%, of the 2, 765 companies reporting in 2010 had direct premium written outside the United States or Canada Not all of these countries are in the European Union, so this number overstates the number of companies directly impacted by Solvency II Indirect q Many U. S. companies use international reinsurers Some U. S. companies reinsure offshore captives q Solvency II will impact reinsurance pricing and collateral requirements q

Financial Services Authority q The Financial Services Authority is exploring ways to reduce costs for U. K. insurers, who will effectively have to comply with both the current and new rules during 2013, due to the U. K. Insurance regulation deciding to delay full implementation of Solvency II until 2014 q Larger U. K. insurers will have to demonstrate some form of Solvency II reporting as well as comply with the FSA’s current individual capital assessment rules

NAIC Solvency Modernization Initiative Process began in 2008 q Represents an alternative framework for insurance solvency regulation q Includes consideration of Solvency II as well as international financial reporting standards and regulation of internationally active insurance groups q For example, ORSA draft proposal effective January 1, 2014 for insurers with annual premium greater than $500 million or groups with annual premium greater than $1 billion q All major policy decisions expected to be made by December 2012 q

Other Thoughts Former FDIC Chairperson Sheila Bair gave the keynote address at a recent NAIC meeting. Speaking about the financial crisis, she said that the non-adoption of Basel II, the banking counterpart to Solvency II, “was the only thing that saved our bacon…We kept our leverage ratios and fought Basel II and I am so glad we fought it off. ” q NAIC President-Elect Kevin Mc. Carty said, “You can’t prevent an AIG by focusing on capital. ” q Basel II did not work for banking, why would Solvency II be expected to work for insurance? q

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