Evolving Criteria - Reinsurance Thought Leadership | Aon Benfield

Since this leads to immediate profit recognition, the
IASB and U.S. Financial Accounting Standards Board
(FASB) have introduced a fourth building block that
avoids the possibility that any profit would be
recognized up-front, the so-called “residual” margin.
In regard to the risk margin, Solvency II provides
detailed guidance on risks and methods to be used.
Solvency II requires, for example, that the cost of
capital method (six percent) will be used for the
determination of the risk margin. In the ED, the IASB
limits the permitted methods to three techniques
without giving much guidance: the confidence interval
(VaR), the conditional tail expectation (TVaR) and the
cost of capital (economic capital). To complicate
matters more, the FASB decided that the measurement
of an insurance contract should not include a separate
risk margin, but the residual and risk margin will be
combined in a composite margin.
The granularity for calculating the risk margin is also
different. For Solvency II, the risk margin should take into
account diversification between lines of business. The
IASB proposes the risk adjustment is determined for a
portfolio of contracts that are subject to broadly similar
risks and managed together as a single pool.
Diversification benefit between portfolios is not allowed.
Further, for short duration contracts (most non-life
contracts with a contract term of one year or less), instead
of the four building blocks method, the IASB decided to
require an “unearned premium” (after deduction of
incremental acquisition costs) approach for the valuation
of the pre-claims liability. Solvency II does not require a
different treatment for short and long duration contracts
and pre-claims liabilities have to be calculated based upon
the three building block approach.
Given this, there is a possibility that reserves will be
calculated differently under Solvency II and IFRS (with
the FASB still in disagreement with the IASB over
certain elements), which further complicates planning
for insurers and adds another element of uncertainty.
Other Regimes
Aon Benfield
Bermuda
A key objective of the Bermuda Monetary Authority
(BMA) is to develop an insurance framework that meets
or exceeds international standards. The stated aim of
the past two years is achieving Regulatory Equivalence
with the U.S. and U.K./Europe, and equivalency with
the Solvency II directive is core to this. The BMA,
however, plans to adapt Solvency II to the Bermuda
market rather than duplicate it. The key steps that
should assist with this include:
> The BMA’s proposals for enhanced disclosures were
defined in a consultation paper on disclosures and
transparency in June 2009
> Class 4 companies now prepare GAAP statements
that the BMA is publishing
> Class 3B companies will have similar requirements
in 2010
> An internal capital model framework for Class 4
companies was established in July 2009 and the
BMA continues to develop this
> A pilot implementation of the application and
review process with selected Class 4 companies was
announced in June 2010
> Pilot companies allowed to use their own internal
capital models, once reviewed and approved by the
BMA, to determine regulatory capital requirements
Canada
The Office of the Superintendent of Financial
Institutions (OSFI) is currently considering allowing
companies to use internal economic capital models in
lieu of the Minimum Capital Test (MCT), and the target
date is 2012 with the following restraints: internal
capital models must not be used to generate a lower
capital benefit over MCT; must at parallel run with
MCT for three years; requires regulatory approval on a
case-by-case basis. Also, OSFI is removing many of the
rules-based guidelines by moving towards a more
risk-based approach where corporate governance
needs to be formalized for companies. Without specific
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