Solvency II – State of play - Grant Thornton

Contents03 Introduction04 Headline findings05 State of play09 Detailed findings09 Composition of respondents11 Preparing for Solvency II19 Going live21 Concluding remarks22 Contacts2 SOLVENCY II – STATE OF PLAY

IntroductionSolvency II has already been dominating theagendas of non-life insurers for a numberof years. And, with the recent delays toimplementation, it looks certain to continueto demand their attention for several more.The preparations for the new regime have required substantialinvestment of time, resources and money and there is no endin sight. But what do insurers really think of Solvency II?Will all the effort, the frustrations and the headaches be worthit once the regime is in place? Will the benefits ultimatelyoutweigh the costs and will the end justify the means?In order to discover the answers to these questions, weundertook a survey of senior executives in the non-lifeinsurance sector during September and October 2012. Weasked them how prepared they are for the brave new worldof Solvency II, what areas they still need to focus on, andhow they view the new regime after so many years of effort.Their answers make for fascinating reading.It is more than three years since our last Solvency IIsurvey. At that time, preparations for the regime werein their infancy and little guidance had been issued. Thecontrast between the responses we received then and now isextremely interesting.We received responses to our latest survey from the UK,Ireland, Continental Europe and Bermuda and from a rangeof different insurance entities. We are enormously gratefulto everyone who took the time to complete the survey – itis self-evident, but nonetheless true, that without you, thisreport would not exist.Regardless of whether or not you responded to thesurvey, we hope that you will find the results as interestingand informative as we do.Simon SheafGeneral Insurance Practice LeaderT +44 (0)20 7728 3280M +44 (0)7792 228065E simon.h.sheaf@uk.gt.comSOLVENCY II – STATE OF PLAY 3

clearly demonstrate a shift in themarket’s perception since, in 2009, thecorresponding percentages were allzero. The implementation process, theconstant delays, the complexity of theregime and the quantity of man hoursthat have been expended preparing forSolvency II, have all resulted in a lossof the market’s hearts and minds. Thisshould be of concern to regulatorsand supporters of Solvency II whowill need to promote the benefitsof the new regime effectively andpersuade the market of its usefulnessin order to ensure buy-in from seniormanagement.Based on the responses that wereceived, it is evident that insurancecompanies are further behind in thepreparations than their peers in theLloyd’s market. This is not a surprisein the light of the Corporation ofLloyd’s efforts to drive the syndicatesthrough the process, which includedthe imposition of strict deadlines,accompanied by significant guidanceand support. However, although thelevel of preparedness is different, it isevident from the responses that bothinsurance companies and Lloyd’smanaging agents have exactly the samepriorities on their agendas for thecoming months and this is in line withour experience of talking to people inthe market.An interesting observation is thatone in ten Lloyd’s managing agentsbelieves that the calculation of thestandard formula is not relevant forthem, despite the fact that regulatorshave the right to require an insurerto calculate its Solvency CapitalRequirement (SCR) on the basis ofthe standard formula even if it is usingan internal model, and therefore theyshould be prepared for that eventuality.Another noteworthy observation isthat although transferring SolvencyII from project basis to business asusual is very high in the agendas ofboth Lloyd’s managing agents andinsurance companies, 3% of the latterbelieve that this is not relevant forthem. This may be explained by thefact that some insurance companiesare not yet fully aware of Solvency IIrequirements, since they still need tomake progress in various Solvency IIelements, as illustrated in detail in themain body of the survey. This could bea signal to regulators to devote moreattention to small and medium insurersby providing further assistance andsupport to ensure these companies willkeep up with the pace and will be fullySolvency II compliant on time.In terms of the calculation of theregulatory capital requirements,Lloyd’s managing agents are obligedby the Corporation of Lloyd’s touse an internal model. However,the same is not true for insurancecompanies and when we asked themhow they proposed to calculatetheir requirements, the results wereenlightening and demonstrated ashift in the market position. At thetime of our 2009 survey, 34% of the6 SOLVENCY II – STATE OF PLAY

insurance company participants hadchosen to use an internal model for thecalculation of their SCR, 8% a partialinternal model, and none had chosenthe standard formula, while 58%were undecided. These percentageshave changed in 2012 with 39% ofthe insurance company participantschoosing to use an internal model,14% a partial internal model and 47%choosing either the standard formula orthe standard formula with UndertakingSpecific Parameters (USPs). This maysuggest that the vast majority of thecompanies that were undecided in2009 ended up selecting the standardformula. An analysis of the responsesindicates that many small to mediuminsurance companies have been putoff the development of an internalmodel by the complicated and timeconsuming internal model approvalprocess, the onerous documentationand validation requirements and theshortage of experienced resources. Thisfinding accords with our experience ofthe market.Interestingly, the most significantconstraint identified by participants inimplementing Solvency II is the lackof certainty around the requirements.This implies that, despite thevoluminous information produced byEIOPA and the regulators, SolvencyII requirements are still not clear. As aresult, companies are concerned aboutinvesting too much time before thefinal details have been clarified in casesome of that time turns out to havebeen wasted in the light of informationthat subsequently emerges. This isperhaps understandable given therecent delays and the potential thatthey could lead to previously resolvedSOLVENCY II – STATE OF PLAY 7

issues being reopened. Nevertheless,we would caution firms againstdelaying for too long while awaitingfurther clarification. There is still asignificant amount of work to do andit is imperative that firms begin totackle it as soon as possible. Althoughsome minor details of the new regimeare expected to change between nowand the final implementation date, thestructure as currently envisaged willnot change substantially.Of some concern is that, even atthis stage, 55% of respondents cited alack of understanding as a constraintand 35% were constrained by a lack ofboard engagement.A further finding is that, althoughthe participants are confident in theirown ability to be fully Solvency IIcompliant by 1 January 2014, with81% of insurance companies and 94%of Lloyd’s managing agents saying thatthey would be, they are less confidentof their peers’ progress with only37% believing that 70% or more ofthe insurance market will be readyby 1 January 2014, and 25% thinkingthat less than 50% of the market willbe ready. This divergence of opinioncould indicate either overconfidencein respondents’ own readiness or anunjustified pessimism about that oftheir competitors.A final interesting insight that theresponses revealed is the market’slimited awareness about IFRS 4 Phase2. Since IFRS 4 Phase 2 is going tochange the way insurers are accountingfor their insurance contracts, it willhave a material impact on insurers’reporting structure. Despite this,more than a third of the market hasnot considered it at all. Although itis understandable that participantsare currently focusing on SolvencyII, it is important that insurers donot underestimate the challenges andthe complexity IFRS 4 will bring andensure they leave sufficient time andresources for them to be addressed.This issue is exacerbated by thefact that IFRS 4 will, like SolvencyII, require substantial changes toIT systems. In our view it will besignificantly more efficient to buildthe requirements of both regimes intoa single project rather than runningseparate sequential projects.8 SOLVENCY II – STATE OF PLAY

Detailed findingsComposition of respondentsType of companiesOur survey was focused on the nonlifeinsurance sector. Of those whocompleted the survey, 50% werefrom insurance companies (includingcomposites and reinsurers) whilst 45%were Lloyd’s managing agents (Fig. 1).Role within organisationThe survey was sent to a wide selectionof senior executives in the insurancesector. Responses were received fromindividuals in a variety of roles.More than a third of the returnedsurveys (39%) were completedby executives in risk managementdepartments, while 23% were returnedby actuaries (Fig. 2). 11% of theresponses came from finance directorsand 7% came from personnel whowere dedicated to implementingand complying with the Solvency IIdirective (ie Solvency II project teams).2% of the responses came from CEOs,while the remaining 18% were returnedby executives in a variety of differentfunctions including compliance, claimsand internal audit.Fig 1: Type of companyLloyd’s managing agency 45%Insurance company 50%Other 5%Fig 2: What is your role within your organisation?CEO 2%FD 11%Actuary 23%Risk 39%Solvency II 7%Other 18%SOLVENCY II – STATE OF PLAY 9

Annual premium incomeAnnual premium income of thecompanies that participated in thesurvey ranged from less than £20mto more than £1bn. We have split theparticipants into three groups; smallfirms (less than £100m), medium firms(between £100m and £500m) and largefirms (more than £500m). On this basis11% of the participants came fromsmall firms, 43% medium firms and46% large firms (Fig. 3).A closer look at the responsesreveals that 67% of the small firmsare insurance companies and 33% areLloyd’s managing agents (Fig. 3). Thecomposition of the medium firms isdifferent, with 42% being insurancecompanies and 58% being Lloyd’smanaging agents. As for the large firms,53% of them are insurance companiesand 47% Lloyd’s managing agents.Fig 3: Annual Premium IncomeSmall 11%Medium 43%Large 46%Insurance company 67%Lloyds 33%Insurance company 42%Lloyds 58%Insurance company 53%Lloyds 47%Gross technical provisionsThe gross technical provisions of thecompanies that participated in thesurvey ranged from less than £50mto more than £3bn. We have split theparticipants into three groups; smallfirms (less than £250m), medium firms(between £250m and £1bn) and largefirms (more than £1bn). On this basis,33% of the participants came fromsmall firms, 28% medium firms and39% large firms (Fig. 4).56% of the small firms areinsurance companies and 44% areLloyd’s managing agents (Fig. 4). Thecomposition of the medium firms isdifferent, with 29% being insurancecompanies and 71% Lloyd’s managingagents. As for the large firms, 67% areinsurance companies and 33% Lloyd’smanaging agents.Fig 4: Gross Technical ProvisionsSmall 33%Medium 28%Large 39%Insurance company 56%Lloyds 44%Insurance company 29%Lloyds 71%Insurance company 67%Lloyds 33%10 SOLVENCY II – STATE OF PLAY

Preparing for Solvency IIFig 5a: Overall, what is your impression of Solvency II?Clearly the most appropriateway to run our businessgoing forwardA necessary evil24%27%30%52%A box ticking exercise4%21%2009More red tape from Brussels7%28%20120% 10% 20% 30% 40% 50% 60%Impressions of Solvency IIGenerally speaking, the insuranceindustry does not appear to accept theneed for Solvency II, with only 24%agreeing that the Solvency II regimeis ‘clearly the most appropriate wayto run our business going forward’(Fig. 5a). Interestingly, the insuranceindustry appears to have becomemore doubtful about Solvency IIover the past three years. This can bedemonstrated by the fact that in 2009,over half of all respondents agreedthat Solvency II regime was ‘clearlythe most appropriate way to run ourbusiness going forward’.27% of the respondents believedthat ‘Solvency II is a necessary evil’;a similar percentage (30%) expressedthis opinion in our 2009 survey. Aninteresting observation is that thepercentage of respondents that chosethe remaining options has increasedsignificantly. 21% believe that SolvencyII is ‘a box ticking exercise’ (thecorresponding percentage in 2009 wasonly 4%) and 28% believe that it is‘more red tape from Brussels’ (in 2009only 7% believed this was the case).All in all, the industry appearsto have become more cynical aboutSolvency II over the last three years.SOLVENCY II – STATE OF PLAY 11

There does seem to be somesuggestion that the attitude towardsSolvency II varies according to role.It is interesting to note that 60% ofactuarial professionals, but only 20%of risk executives, believe that SolvencyII is ‘more red tape from Brussels’,while the corresponding percentagesthat believe that Solvency II is ‘a boxticking exercise’ are both 47% (Fig.5b and Fig. 5c). In 2009, all of thesepercentages were zero. Consequently,it is safe to conclude that actuariesand risk professionals have becomemore sceptical about the usefulness ofSolvency II over the past three years.This increasing scepticism issupported by the fact that only 21%of CEOs and finance directors believethat ‘the Solvency II regime is clearlythe most appropriate way to run theirbusiness going forward’ (in 2009 thepercentage was almost double, standingat 40%) (Fig. 5d). Risk executivesalso demonstrated a sharp fall in theirsupport, since the percentage whobelieve that ‘the Solvency II regime isclearly the most appropriate way torun our business going forward’ hasreduced by nearly a third within threeyears, from 75% in 2009 to 53% in2012. This accords with our experienceof talking to people in the market.We have encountered a number ofcompanies where the implementers andthe Board are convinced that they willnot run the business based on SolvencyII, but based on internally developedmetrics that will be more appropriatefor them.Fig 5b: More red tape from Brussels60%50%40%30%20%10%0%20092012Actuary60%0% 0%Fig 5c: A box ticking exercise50%40%30%20%10%0%20092012ActuaryRiskRisk20%47% 47%0% 0%Fig 5d: Clearly the most appropriate way to run our business goingforward80%70%60%2009201275%50%40%30%40%53%20%10%21%0%CFO/FDRisk12 SOLVENCY II – STATE OF PLAY

Fig 7a: For each of the following elements of Solvency II, please rate your preparations (Lloyd’s):100%80%9%3%31%16%53%23%32%3%13%84%23%61%39%Not relevantNot startedSignificantly behind60%40%56%16%10%52%Slightly behindOn trackAhead13%29%Complete20%19%13%0%Calculationof standardformulaDemonstratinguse/embeddingStress andscenariotestingReporting anddisclosurerequirements(Pillar III)3%Transferringto businessas usualRiskappetiteFig 7b: For each of the following elements of Solvency II, please rate your preparations (Insurance Companies):100%80%60%3% 3% 3% 3%3%5%9%27%11%8%6%31%33%22%54%51%43%62%58%5%27%43%Not relevantNot startedSignificantly behindSlightly behindOn track40%20%3%27%19%8%16%AheadComplete0%Calculation ofstandard formula6%Demonstratinguse/embedding8%Stress andscenariotesting3%Reporting anddisclosurerequirements(Pillar III)Transferringto businessas usualRiskappetiteImplementation progressAs expected, Lloyd’s managing agentsare generally better prepared forSolvency II than insurance companies.The vast majority of Lloyd’smanaging agents and insurancecompanies (87% and 84% respectively)have completed (or are ahead of plan/on track with) the calculation of thestandard formula (Fig. 7a and Fig. 7b).However, it is interesting that 9% ofLloyd’s managing agents (almost onein ten) believe that the calculation ofthe standard formula is not relevantfor them, despite the fact that theregulator has the right to request aninsurer to calculate its Solvency CapitalRequirement (SCR) on the basis of thestandard formula, even if it is using aninternal model [Solvency II Directive,Article 112 (7) and Article 129(3)].The vast majority of Lloyd’smanaging agents (more than 80%)have completed (or are ahead of plan/on track with) a significant number ofSolvency II requirements. However,almost one in four (23%) of theLloyd’s respondents are slightly behindplan on developing stress tests andtransferring Solvency II from a projectbasis to business as usual (Fig. 7a).Perhaps unsurprisingly, insurancecompanies are even further behindin these two areas, with 30% of therespondents significantly behind/slightly behind on developingstress and scenario tests and 39%significantly behind/slightly behind ontransferring to business as usual.It is interesting and a little worryingthat 3% of insurers believe thattransferring Solvency II from a projectbasis to business as usual is not relevantfor them.Based on the responses thatwe received, it is evident that thepreparations of insurance companieslag behind their peers in the Lloyd’smarket. Apart from developing stressand scenario tests and transferring tobusiness as usual, which were describedearlier, insurance companies havefurther to go in various Solvency IIelements such as demonstrating the useand embedding of internal model (40%behind plan), reporting and disclosure(35%) and risk appetite (32%). Thisis not unexpected in the light of theCorporation of Lloyd’s effort to drivethe syndicates through the process,which included the imposition of strictdeadlines, accompanied by significantguidance and support. However, itdoes demonstrate the success ofthose efforts.14 SOLVENCY II – STATE OF PLAY

ConstraintsWe asked respondents about theirmain constraints in preparing for thenew regime. The most significant onesidentified in our survey are that firmsare awaiting further clarification as towhat Solvency II will require (given asa constraint by 91% of respondents),that they lack the necessary resources(85%) and that they have data issues(78%) (Fig. 10a). A relatively highpercentage of the respondents (75%)also considers the uncertainty aroundthe actual Solvency II implementationdate to be a constraint. Of someconcern is that, even at this stage,55% of respondents cited a lackof understanding, and 35% wereconstrained by the lack of engagementat boardroom level.A closer look at the responses thatwe received reveals that althoughLloyd’s managing agents are, asexpected, generally more prepared forSolvency II than insurance companies,they still have many constraints. 91%need further clarification regardingSolvency II requirement, 84% do nothave adequate resources, while 75%have data issues and 65% consider theuncertainty over implementation dateto be a constraint (Fig. 10b).Fig 10a: What are the main constraints in your Solvency II preparations?100%80%2%64%9%48%4%21%48%2%44%15%41%22%62%Not relevant60%No constraint50%40%20%30%43%27%44%16%Slight constraintSignificant constraint0%5%Lack of boardengagementLack ofclarification ofSolvency IIrequirementsUncertainty overimplementationdate5%Lack ofunderstandingShortage ofresourcesData issuesFig 10b: What are the main constraints in your Solvency II preparations? (Lloyd’s)100%80%77%9%50%3%32%3%52%16%31%25%59%Not relevant60%55%No constraint53%40%41%42%Slight constraintSignificant constraint20%20%10%16%0%3%Lack of boardengagementLack ofclarification ofSolvency IIrequirementsUncertainty overimplementationdate3%Lack ofunderstandingShortage ofresourcesData issuesSOLVENCY II – STATE OF PLAY 17

Going liveImplementation dateWith impeccable timing, the surveywas launched just before the failureof the Omnibus II talks, but by thetime most respondents completed thesurvey, it was clear that the talks hadfailed to reach a consensus and thatthe implementation date of the newregime would have to be deferred.Consequently it was not surprisingthat 97% of respondents believed thatSolvency II will be delayed (Fig. 12).Following the failure of the OmnibusII talks it quickly became apparentthat the delay to implementation wasgoing to be at least a year and, while42% of the participants believed thatthe delay would only be a single year,51% believed that ‘it will be delayed bymore than one year’ and an especiallypessimistic 3% believed that ‘it willnever happen’.Fig 12: Do you think Solvency II will go live on 1 January 2014 or will it bedelayed further?It will go live on1 January 2014 3%It will be delayed byless than one year 3%It will be delayed byone year 42%It will be delayed bymore than one year 51%It will never happen 3%Will you be ready?There are encouraging signs thatcompanies are proceeding with theirpreparations for Solvency II. Even nowthat the implementation date has beenpostponed, only 3% of the insurancecompanies and none of the Lloyd’smanaging agents felt that, if required,they would definitely not be readyto comply with the new regime by 1January 2014. Despite the ambiguityaround the implementation date, 94%of the Lloyd’s participants and 81%of insurance companies believe that, ifrequired, they will be fully SolvencyII compliant by 1 January 2014. Only6% of Lloyd’s participants and 16%of insurance companies were not sure(Fig. 13).Fig 13: If your company is required to comply with Solvency II by 1 January2014, will it be ready?Lloyd'sInsurancecompany0% 20% 40% 60% 80% 100%Yes No Not sure3%94% 6%81% 16%SOLVENCY II – STATE OF PLAY 19

Will the market be ready?However, there is less confidence aboutcompetitors’ preparations. The finalquestion of the survey was about theperception that the participants hadwith regards to the preparedness ofthe insurance market as a whole. Basedon the responses that we received, it isclear that although the participants areconfident in their own readiness, theydo not share the same confidence fortheir peers, since only 37% believe that70% or more of the insurance marketwill be ready by 1 January 2014 if sorequired (Fig. 14). Exactly the samepercentage believe that between 50%and 70% of the market will be readyby then, and a substantial 25% of theparticipants believe that 50% or lesswill be ready by 1 January 2014.This divergence of opinion betweenrespondents’ views of their ownpreparations and those of their peerscould indicate either overconfidence intheir own readiness or an unjustifiedpessimism about that of theircompetitors.Fig 14: If companies are required to comply with Solvency II by 1 January2014, what percentage of the insurance market do you think will be ready?100% 3% 7%90%-100%70%-90%50%-70%30%-50%10%-30%

Concluding remarksOur survey has identified severalinteresting points relating to thepreparedness of the non-life insurancesector for the Solvency II regime. Inparticular, it is clear that the negativitytowards the new regime has increasedmarkedly over the last few years.Although some negativity was evident inour 2009 survey, the level of scepticismappears to have grown substantially. Thishas in part been caused by the constantdelays, the increasing complexity of theregime, the quantity of man hours thathave been expended in preparations andthe shortage of experienced resources.It is interesting but regretful that thevast majority of the market believesthat sound principles in the Solvency IIDirective have been undermined by thecomplexity of the implementation.With this level of negativityand the latest significant delay toimplementation, it would be all too easyfor insurers to take the opportunity tohalt their preparations. However, wewould caution against this. There is stilla significant amount of work to do andit is best that firms begin to tackle it assoon as possible. Although some minordetails of the new regime are expectedto change between now and the finalimplementation date (whenever thatmay be!), the structure as currentlyenvisaged will not change substantially.And if insurers lose momentum at thisstage, it is going to be far more difficultand far more costly for them to pick upthe pace later.SOLVENCY II – STATE OF PLAY 21

ContactsSimon SheafGeneral Insurance Practice LeaderT +44 (0)20 7728 3280M +44 (0)7792 228065E simon.h.sheaf@uk.gt.comStephen KellyRisk & Capital Management Practice LeaderT +44 (0)20 7728 3073M +44 (0)7976 963187E stephen.f.kelly@uk.gt.com22 SOLVENCY II – STATE OF PLAY

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