Odomirok Ch 25: Solvency II

Question 1

3 pillars of Solvency II:

Answer 1

• Pillar 1: Quantification: Quantitative capital requirements (Solvency Capital Requirement & Minimum Capital Requirement)
• Pillar 2: Governance: Supervisory Activities (Internal control & risk management; Supervisory review process)
• Pillar 3: Transparency: Supervisory reporting & public disclosure

Question 2

Briefly describe the Solvency Capital Requirement (SCR):

Answer 2

The SCR is the required capital to limit the probability of ruin over the year to 0.5% (protect against the 99.5% VaR). Companies with lower capital are subject to regulatory intervention.

Question 3

Describe Minimum Capital Requirement

Answer 3

Companies with lower capital not permitted to operate

Question 4

3 methods to calculate the SCR:

Answer 4

1. Standard formula: a spreadsheet provided by the regulator
2. Internal models
3. Mix of Both

Question 5

2 things that Pillar 2 (Supervisory Review) provides supervisors with:

Answer 5

1. Means of identifying firms with a higher risk profile

2. Power to intervene

Question 6

List the 4 functional areas that need to be addressed by the insurer’s governance structure:

Answer 6

1. internal audit
2. actuarial
3. risk management
4. compliance

Question 7

What does the “internal audit” functional area require that the insurer do:

Answer 7

Produce a report at least annually to the board of directors about any deficiencies of the internal controls & any shortcomings in compliance with internal policies & procedures.

Question 8

What does the “actuarial” functional area require that the insurer do:

Answer 8

• ensure that the methods and assumptions used to derive the technical provisions are reasonable.
• perform a retrospective analysis of best estimates vs experience.
• opine on the overall underwriting policy and adequacy of reinsurance arrangements

Question 9

What does the “risk management” functional area require that the insurer do:

Answer 9

• monitor the risk management function & maintaining an aggregate view
• ensure that the internal model has been integrated with the risk management function

Question 10

What does the “compliance” functional area require that the insurer do:

Answer 10

• ensure that the internal control system is effective to comply with all applicable laws & regulation
• promptly report any compliance issues to the board

Question 11

Briefly describe the Own Risk & Solvency Assessment (ORSA):

Answer 11

An internal assessment of the solvency need based on the risk profile.

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 12

What does ORSA need to contain at a minimum:

Answer 12

• Overall solvency need (based on the specific risk profile, approved risk tolerance limits, business strategy)
• Compliance with capital requirements & the requirements of the technical provision
• Extent to which the risk profile deviates significantly from the assumptions underlying the SCR

Question 13

Briefly describe Pillar 3 (Supervisory Reporting/ Public Disclosure):

Answer 13

This focuses on increasing the transparency of the insurer’s risks & capital position. It provides the means by which the capital & regulatory position derived from Pillars 1 & 2 are reported to the supervisor & financial markets.