IFRS and Solvency II

Question 1

Definition of an insurance contract under International Financial Reporting Standards (IFRS) 4

Answer 1

A contract under which one party (the insurer) accepts significant insurance risk from another party (the policyholder) by agreeing to compensate the policyholder if a specified uncertain future event (the insured event) adversely affects the policyholder

Question 2

Current requirement in the U.S. for a contract to qualify as reinsurance comparison

Answer 2

• IFRS 4: the trigger to meet this definition includes only an assessment of insurance risk and does not have to include timing risk, as is required in the U.S.
• The US requires indemnification, whereas IFRS specifies compensation.

Question 3

3 pillars of Solvency II

Answer 3

• Quantitative Requirements/ Quantification:
• Supervisory Review/ Governance:
• Supervisory Reporting/ Transparency:

Question 4

Quantitative Requirements/ Quantification

Answer 4

Each company must calculate their required capital for the SCR requirement. (Capital to reduce firm failure to 0.5%). They can use an internal model, the defined formula, or a combination of the two.

Question 5

Supervisory Review/ Governance

Answer 5

This provides supervisors with a means of identifying firms with a higher risk profile, and the power to intervene. It also requires that firms conduct an ORSA

Question 6

Supervisory Reporting/ Transparency

Answer 6

This focuses on increasing the transparency of the insurer’s risks & capital position. The intention is to provide the market with sufficient information to exercise its disciplinary function.

Question 7

Solvency capital requirement under Solvency II

Answer 7

The necessary economic capital to limit the probability of ruin of the firm to 0.5%. The company may be subject to supervisory action if it drops below this level

Question 8

Own risk self-assessment (ORSA)

Answer 8

-The ORSA can be defined as the entirety of the processes and procedures employed to identify, assess, monitor, manage, and report the short and long term risk a (re)insurance undertaking faces or may face and to determine the own funds necessary to ensure that the undertaking’s overall solvency needs are met at all times

Question 9

Determine actions of regulator based on calc underlying Solvency II quantitative capital requirements

Answer 9

• do total fair value of liabilities
• Risk margin discount rate = risk free rate+illiquidity prem
• avg required capital = SCR
• total fair value of liab=PV payments/liab + associated risk margin
• compare (total fair value + SCR) to actual assets
• required assets= total fair value + SCR

Question 10

Differences between RBC and Solvency II that could result in different levels of regulatory action

Answer 10

• Solvency II uses IFRS assets, while RBC is based on SAP values. This causes differences in the asset valuation.
• Required capital under Solvency II is based on the 99.5% VaR, while RBC is not based on modeled results.
• Reserves are not discounted under RBC, while Solvency II discounts reserves and adds a risk margin.
• Solvency II can be tailored to individual companies (ORSA), while RBC uses the same set of formulas for all companies.
• RBC does not consider many risks which Solvency II does, including Interest rate risk, Catastrophe risk, and Operational risk
• RBC has four action levels based on the RBC ratio, while Solvency II has two quantitative requirements (SCR and MCR).
• Solvency is principle based, while RBC is rule based

Question 11

3 requirements for the company’s internal model to be approved for use in calculating Solvency II quantitative capital requirements

Answer 11

• Model is used in running the business
• Model has been validated by an independent third party
• Model is documented appropriately