August 29th, 2009

Solvency II – Summary of CEIOPS March Consultation Papers: Index

Posted at 1:00 AM ET

Preview: The Committee of European Insurance and Occupational Pensions Supervisors (CEIOPS) published its first set of Consultation Papers, 12 in all, on Level 2 Implementing Measures on Solvency II in March. These drafts have been developed to expand on the general approach outlined in the Solvency II Directive Proposal that was adopted in December 2008. The second set of 24 papers was published by CEIOPS at the beginning of July. The third set is scheduled for November-to-December 2009.

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Transparency and Accountability for Supervisors: Consultation Paper No. 34 addresses transparency and accountability for supervisors, expanding on Article 30 of the Solvency II Directive. The Paper aims to make information related to supervision available in a timely manner to all interested parties. Its two main objectives — effectiveness of supervision and convergence of supervisory practice — are achieved by facilitating the interaction between the regulator and the supervised entity, ensuring the transparency of supervisory requirements, and providing easy access to the disclosed information. The result is to facilitate the comparison of supervisory approaches.

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System of Governance: Each (re)insurer’s system of governance should:

  • Establish and maintain effective cooperation, internal reporting and communication at all relevant levels.
  • Have a clear, consistent and documented organizational structure.
  • Establish, implement and maintain decision-making procedures
  • Establish information systems that produce sufficient and relevant information concerning all business activities and risks to which the entity is exposed.
  • Establish and maintain adequate risk management, compliance, internal audit and actuarial functions.

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Technical Provisions — Lines of Business on the Basis of which (Re)Insurance Obligations Are to be Segmented:  (Re)insurance companies segment their obligations into homogeneous risk groups when calculating technical provisions. CEIOPS recommends a minimum level of segmentation for technical provisions and will continue developing its advice on segmentation, particularly with regard to health insurance.

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Technical Provisions — Elements of Actuarial and Statistical Methodologies for the Calculation of the Best Estimate: The best estimate is defined as “the probability-weighted average of future cash-flows, taking account of the time value of money (expected present value of future cash-flows) using the relevant risk-free interest rate term structure.” It is to be calculated gross, with recoverables from reinsurance or special purpose vehicles (SPVs) calculated separately.

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Technical Provisions — Assumptions about Future Management Actions: For Solvency II compliance, future management actions are primarily relevant in life insurance and should be reflected in the assessment of cash-flows (e.g., changes in asset allocations, bonus rates).

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Technical Provisions — Treatment of Future Premiums: The first core principle is that a (re)insurance contract should be recognized as a contract when the entity becomes a party to it. The contract is deemed to have expired when its underlying obligations have expired. Any allowance for options (e.g., paying future premiums, increased cover) under a particular contract should only be taken into account if it increases the best estimate of the liability. The second core principle is that future premiums as well as corresponding benefit payments and expenses which relate to an option or a guarantee can only be considered if their inclusion increases the best estimate of the underlying liability.

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Valuation of Assets and Other Liabilities: Consultation Paper 35 sets out principles with regard to the valuation of assets and liabilities (other than Technical Provisions). The objective is to determine the economic (or fair) value of the assets and liabilities and the amount at which they could be exchanged between knowledgeable willing parties in an arm’s length transaction. CEIOPS recommends adopting the International Financial Reporting Standard (IFRS) as a reference framework — with additional specifications to be provided only where IFRS is not compatible with the Solvency II Directive. This would be the case, for instance, for items that can be measured at historical cost under IFRS. The consideration of assets for solvency purposes further requires that all the risks inherent to them be addressed through solvency requirements.

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Criteria for Approval of Ancillary Own Funds: Own funds are comprised of “basic own funds” and “ancillary own funds.” Ancillary own funds are only accepted as own funds under certain limited circumstances. Examples of ancillary own funds are unpaid common shares or letters of credit and guarantees.

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Special Purpose Vehicles: Special purpose vehicles (SPVs) are used to transfer insurance risks to the capital markets. This document addresses the authorization, regulatory requirements, and scope of supervisory review of SPVs under Solvency II. The requirements refer only to SPVs domiciled in the European Economic Area (EEA); SPVs established outside the EEA are not subject to the rules discussed in this paper.

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Allowance of Financial Mitigation Techniques: CP31 sets out the principles an entity must adhere to in order to allow the recognition of financial mitigation techniques (e.g., financial derivatives) for Solvency Capital Requirement (SCR) purposes. It states the capital requirement should allow for an appropriate reduction to reflect the mitigation techniques in place while avoiding allowing deductions based on inappropriate mitigation techniques.

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