Issue 8 …

                                                           Issue 8        May 2008




Hello and welcome to the latest Solvency II Bulletin, produced by the Association of
British Insurers (ABI)
In this issue:
     - Negotiations on Solvency II Directive nearing conclusion
     - End of CEIOPS consultation process on Groups and Proportionality
     - Solvency II and Basel II
     - Cost of Capital and the definition of 1 year Value at Risk

Negotiations on Solvency II Directive nearing conclusion

Update on Timeline for the Level 1 Directive

3 June 2008:    ECOFIN ­ EU Finance Ministers to discuss `General Approach'
11 June 2008:   Deadline for amendments in the European Parliament
1 July 2008:    French Presidency of the EU
15 July 2008:   Exchange of views ion the European Parliament
22 Sep 2008:    ECON Committee vote
Oct 2008:       European Parliament Plenary vote


The Level 1 negotiations are taking place under the Slovenian Presidency, ahead of
the French taking over in July 2008. The Slovenians are seeking an agreement on the
compromise text they published on 30 April and it is likely a final view on the solo
specification will be reached. However, the ABI is concerned with some of the
amendments suggested including:

- Article 74 on the valuation of assets and liabilities: there still is no distinction
between insurance and non-insurance liabilities in the compromise text.
- Article 75 on general provisions: the term `current exit value' has been replaced by
the value of technical liabilities if insurance and reinsurance obligations were
transferred. We suggest `technical provisions shall be calculated on a market
consistent basis' as proposed in our list of amendments.
- Article 90 on surplus funds: we believe further discussion is still needed on this
issue.
- Article 101 on the treatment of future new business in the calculation of the
SCR: the proposed amendment appears to tighten the requirements for insurers to
add in risks to their SCR from existing and future business over the next 12 months but
takes no account of profit.
- Article 131 on the freedom of investment: we strongly disagree with the proposed
amendment, that Member States could require from undertakings to invest in certain
types of assets covering contracts where the policyholder bears the risk. We would
support a `prudent person' approach as referred to in CEIOPS' CP 19 while agreeing
to greater Conduct of Business and selling requirements in terms of disclosure.


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In the European Parliament

On Thursday 29 May, the European Parliament's Committee on Legal Affairs (Juri)
voted on the compromise amendments proposed by Sharon Bowles. Among the
suggested amendments the ABI strongly supports:

                               On the MCR, Amendments 11, 32 and 40, which
                               advocate the compact approach and legal certainty for
                               the MCR calculation.

                               On the college of supervisors. Amendment 14 which
                               requires supervisors to be detached from their national
                               mandates is very helpful in ensuring an impartial advice
                               from CEIOPS.

On public disclosure, we support a test of `undue commercial harm' to the
undertaking instead of `significant undue advantage' as proposed by Amendment 13.

On the use of actuarial and statistical techniques, we agree with Amendments 15
and 17 to reintroduce `applicable and relevant' as it already appears under Article 83 in
the Framework Directive.

End of CEIOPS consultation process on Groups and Proportionality
On 25 April 2008, the ABI issued its finale responses to CEIOPS' Consultation Papers
on Proportionality (CP 24) and Groups (CP 25).

· CP 24
We are broadly satisfied with CEIOPS' approach to proportionality.
  - the proportionality principle should be used to make the application of the
      Solvency II regime easier for smaller firms.
  - it should not lead to additional requirements for more complex risk portfolios.
  - when deciding on scale considerations, CEIOPS should be careful not to
      prevent simplifications from being applied due to materiality thresholds.
      Materiality is not always easy to determine in such cases.
  - further work is currently in progress at the ABI and CEA to provide a definition
      of `nature', `scale' and `complexity'. The outcome will be crucial in the
      application of the proportionality principle.

· CP 25
We are very concerned by CEIOPS' interpretation of the group support regime (GSR)
  - It is inconsistent with the draft Framework Directive for Solvency II.
  - CEIOPS advocates more stringent supervisory requirements for groups that
      use the GSR. It also believes groups should hold capital in excess of the group
      SCR up to the amount of group support declared.
  - In doing so, groups would be required to hold a `sum-of-solo SCRs'. This is in
      direct contradiction to the Framework Directive.

For further details, please refer to our full responses here
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Solvency II / Basel II


           Basel II is the European banking industry's most recent capital
           measurement system, to ensure the stability of the banking industry and is
           therefore of great interest to those who follow the Solvency II Directive.

             Whilst the banking and insurance sectors can learn a lot from the other in
             terms of capital assessment, some differences remain. The current
difficulties in the banking sector also highlight that Basel II does not anticipate all
eventualities. Where there are similar products or risks, these should be treated in a
similar way under each regime, but in many areas the risks are different in nature and
duration and so the regulation must reflect that.

 To simplify greatly, in banking much of the business relies on borrowing short term to
lend long to customers, so your liabilities may be quite liquid but your assets illiquid. In
insurance you typically receive the premium payment up front, so your assets are (or
may be) quite liquid, whereas your liabilities will often be quite long term and `slow
burn'.

Accordingly, Solvency II involves a more advanced idea of risk assessment, a
complete view of the risk management framework that is necessary for the solvency of
insurers. The Basel II framework deals mainly with capital assessment and has
specific rules for valuing different types of financial instruments particularly as far as
their market risk is concerned. Credit risk and operational risk are also included, but
not spread risk and concentration risk which are included in Solvency II. The
importance of internal models is emphasized in both.

As the detailed requirements of Solvency II are developed, differences between the
regimes may become evident and consideration will need to be given as to how these
are addressed.

So what does "99.5% 1-year Value at Risk" actually mean?
Whilst this is a technical measure with significant actuarial and statistical underpinning,
its meaning is quite straightforward.

The 99.5% refers to a 1-in-200 probability. Sometimes this is referred to as a "one-in-
200 year event". Perhaps more accurately, what we mean is that an insurer must
consider all the different possible outcome of events over the next year and then rank
the 200 different "outcomes". To meet the "99.5% 1-year VaR" test a company would
have to have enough capital to remain solvent in 199 of those 200 different possible
"outcomes" covering the next 12 months.

For those unable to complete all the work themselves using an internal model,
Solvency II provides a "standard approach" to calculate the SCR which has been
calibrated to ensure that most insurers would have enough capital to meet the "99.5%
1-year VaR" standard. But of course this will never be as accurate as a calculation
using an internal model.
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Cost of Capital

There are different valuation approaches for this purpose such as
· IASB transfer approach;
· Reference entity approach;
· Settlement approach;
· Fulfilment approach

CEIOPS advocates the `Reference entity approach'. The CRO Forum however
supports the `Fulfilment approach' which we agree with as it is not overly complex, it
provides for diversification effects and allows entity specific assumptions when market
data is not available.
You can view the CRO Forum Paper here


Key dates

31 July         Deadline for group QIS4 return
07 July         Deadline for solo QIS4 return
10 June         ABI Conference on Solvency II (London)
03 June         Council of Ministers meeting
Useful links:

ABI              www.abi.org.uk/solvency2
CEA              www.cea.assur.org
CEIOPS           www.ceiops.org/content/view/118/124
CRO Forum        www.croforum.org/
EU              http://ec.europa.eu/internal_market/insurance/solvency_en.htm
FSA             www.fsa.gov.uk/Pages/About/What/International/solvency/index.shtml
IAIS            www.iaisweb.org/
HM Treasury     www.hm-treasury.gov.uk/index.cfm

To find out more on these issues please contact our Solvency II team:

Paul Barrett         Paul.Barrett@abi.org.uk             020 7216 7636
Elizabeth Larkin     Elizabeth.larkin@abi.org.uk         020 7216 7354
Sophie Lloret        sophie.lloret@abi.org.uk            020 7216 7409
For feedback and comments on this bulletin, or to be added to the distribution list
please email Erfan.Hussain@abi.org.uk or call him on 020 7216 7411.


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