Solvency ii Association

1200 G Street NW Suite 800 Washington, DC 20005-6705 USA Tel: 202-449-9750 www.solvency-ii-association.com

Dear member, Today we will start from a letter:

EU to Gabriel Bernardino (EIOPA)

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The new UK Regulator: The Financial Conduct Authority
The Financial Conduct Authority (FCA) will be the new regulator whose vision it is to make markets work well so consumers get a fair deal. It will be responsible for requiring firms to put the wellbeing of their customers at the heart of how they run their business, promoting effective competition and ensuring that markets operate with integrity. The FCA will start work in 2013, when it will receive new powers from the Financial Services Bill that is currently going through parliament. The Journey to the FCA sets out how we will approach our regulatory objectives, how we intend to achieve a fair deal in financial services for consumers and where we are on this journey.

Changes to authorisations
The UK regulatory structure will be changing in 2013, when the FSA will split into two regulatory bodies the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA). In April 2012, Supervision adopted the internal-twin peaks structure, and now Authorisations are implementing a similar structure, with
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assessments carried out by both the Prudential Business Unit (PBU) and the Conduct Business Unit (CBU). This change will only affect firms that will be dual regulated in future. The application submission process will not change and we will continue to seek to meet our statutory deadlines. What will change is how the application is processed internally. There will be a CBU case officer and a PBU supervisor responsible for each application and they will coordinate to minimise duplication or the impact on applicant firms and individuals. The final decision will need to be agreed by both the PBU and the CBU to ensure a single FSA decision during transition to the new regulatory structure. These changes will allow us to start to deliver, as far as possible, a model that will mirror the future authorisation procedures in the PRA and the FCA.

What is happening to the FSA Handbook?
At legal cutover, the FSA Handbook will be split between the FCA and the PRA to form two new Handbooks, one for the PRA and one for the FCA. Most provisions in the FSA Handbook will be incorporated into the PRA’s Handbook, the FCA’s Handbook, or both, in line with each new regulator’s set of responsibilities and objectives. Users of the Handbook will be able to access the following online: 1. The PRA Handbook, displaying provisions which apply to PRAregulated firms 2. The FCA Handbook, displaying all provisions which apply to FCA-regulated firms; and
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3. To support the transition, a central version which will show the provisions of both Handbooks, with clear labels indicating which regulator applies a provision to firms. The new Handbooks will reflect the new regulatory regime (for example, references to the FSA will be replaced with the appropriate regulator), and in some areas more substantive changes will be made to reflect the existence of the two regulators, their roles and powers. (This is likely to include such aspects as the future processes for permissions, passporting, controlled functions, threshold conditions and enforcement powers.) The more substantive changes will be consulted on before the PRA and the FCA acquire their legal powers. Changes to the FSA Handbook as a result of EU legislation and FSA policy initiatives will continue throughout this work. After acquiring their powers, the FCA and the PRA will amend their own suites of policy material as independent bodies in accordance with the processes laid down in the Financial Services Bill, including cooperation between them and external consultation.

What does this mean for firms?
This approach to the Handbooks for the FCA and the PRA has been planned to ensure a safe transition for firms and the new regulators as the new regime is introduced. Firms will have a new regulator or regulators, and will consequently need to assess how the new Handbooks of these bodies will apply to them. Dual regulated firms will need to look to both the PRA and the FCA Handbooks, and FCA regulated firms to the FCA Handbook.
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When will the changes be in the Handbook?
We expect to publish the new Handbooks before legal cutover. This will allow firms and others time to adjust to the application of the new Handbooks before the FCA and the PRA are fully operational. The new Handbooks will not be available in detail before this. Alongside the publication, we will publish material on how to interpret the application of the Handbooks, where this is not dealt with in the Handbooks themselves. The FSA will continue to make changes to its Handbook in accordance with the normal procedure, until the new bodies acquire their legal powers. The FSA Handbook will remain in force until the FCA and PRA acquire their legal powers.

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Launch of the Journey to the FCA
Speech by Martin Wheatley - Managing Director, FSA, and CEO Designate, FCA at the Launch of the Journey to the FCA event Good morning. I would like to thank the Minister Greg Clark for joining us today, for his supportive words – and for demonstrating the Government’s commitment to working alongside us to deliver better conduct regulation. I would also like to thank Thomson-Reuters for hosting this morning. Today is a big step forward on the road to becoming the new regulator, and I am glad that you are all here to join us as we launch the Journey to the FCA. The FCA offers a huge opportunity for the regulator and firms to start afresh, and work in partnership to reset how we deal with conduct in financial services. We see it as the role of the regulator to not only make the relevant markets work well but also to help firms get back to putting their customers at the heart of how they do business. Regulation has a huge impact on the people and businesses that rely on financial services, and we should never forget this. We have approached the creation of the FCA in a thoughtful and considered way, as the document we are sharing with you today shows. We will regulate one of our most successful industries, central to the health of our economy and a provider of two million UK jobs. This makes our job an important one, and it will mean that we carry out our work in a way that is as open and accountable as possible. We spent the summer engaging with consumer organisations, and 500 firms from all areas of financial services, as we developed our thinking on the FCA.
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This allowed us to gather useful feedback and we will continue this open working in the FCA. We aim in the Journey to the FCA to demonstrate what our new organisation will mean for the firms we regulate and the consumers we are here to help protect. I encourage you all to read it, and to give us your views. We are clear about the type of regulator we want to become, and we want to work with all of our stakeholders to get there and deliver regulation that works better. You have not yet had a chance to read the document, so let me explain a bit more about what the FCA is going to be about. The FCA has been set up to work with firms to ensure they put consumers at the heart of their business. Underlining this are three outcomes: 1. Consumers get financial services and products that meet their needs from firms they can trust. 2. Firms compete effectively with the interests of their customers and the integrity of the market at the heart of how they run their business. 3. Markets and financial systems are sound, stable and resilient with transparent pricing information. Reforming regulation is not just good for consumers, it will also be good for firms. The industry’s standing has suffered as the mis-selling scandals and other problems have taken their toll. This has damaged the reputation of firms across the industry, whether directly involved or not. We need to work with you to put that right. While much of what we will do is new, we will also build on what has worked well under the FSA. We will keep up our policy of credible deterrence, pursuing enforcement cases to punish wrongdoing.
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And our markets regulation will continue to promote integrity and carry on the FSA’s fight against insider dealing, which has secured 20 criminal convictions since 2009. We will continue to keep unauthorised firms from trying to take advantage of consumers. We will set high expectations for those firms that want to enter financial services, while still allowing innovation and good ideas to flourish. And we will take forward a strong interest in the fair treatment of customers – an agenda that has been around for many years, but is still key to the FCA. There will, however, be important changes, and our approach will be more forward-looking, better informed, and we will have a greater appetite to get things done. A new department will act as the radar of our new organisation – combining better research into what is happening in the market, and analysis of the risks to our objectives. This will then feed into our policymaking and our supervision of firms. We want to really understand what is happening to your customers, the deal they are getting and the issues they face. This will include getting a better understanding of why consumers act in the way they do, so we can adapt our regulation to their common behavioural traits. Fewer firms will have regular direct contact with supervisors, as we shift resources to allow us to deal more quickly and effectively with emerging issues, and run more cross-industry projects to get to the root cause of problems. We will have new partners to work with and our relationship with the new Prudential Regulation Authority will be crucial, and driven by a culture of cooperation.
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We will aim to bring our expertise to international debates, so that EU and international policymaking works for UK consumers and firms. All of this will be delivered by a new culture in the FCA. We will encourage our staff to be more confident in making bold, firm and predictable decisions. To help us do our job, the Government intends to give the FCA new tools to ensure that consumers get products that meet their needs. This builds on one of the key lessons from past problems, which is that regulation is often more effective if it steps in early to pre-empt and prevent widespread harm. We will reflect this in our supervision work when we look at how firms design and sell their products. But a key new power will mean that we can step in and ban the sale of products that pose unacceptable risks to consumers for up to 12 months, without consulting first. We will also be able to ban misleading advertising. We will use these new tools in a measured way – and while we will act sooner, and more decisively, our approach will be based on a proper understanding of the issues and a full consideration of the potential solutions. So whilst there may be times when we have to act rapidly, this is not something that firms should be afraid of. Firms selling the right products, in the right way, to the right consumers have little to fear. Our new approach will mean that we will take competition into account in all our work. We will weigh up the impact on competition of new measures we propose.
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We will also consider whether competition could lead to better results than other action we could take. In our work here, and in other areas, I am very conscious that we have to work with firms. Making regulation work better for us is also about allowing firms room to try new ideas and develop their business. Promoting competition will play an important part in this. We are not here to stand in the way of progress that will be of benefit to consumers. Our goals as the FCA are clear: we will work for an industry that is better at serving the needs of its customers. I see this as an opportunity – not just for us but for the industry. We can do our job better if we work with you, and I am pleased that so many of the chief executives that I speak to are talking the same language and have committed to rebuilding confidence and trust, and reconnecting with their customers. It is great hearing about these good intentions, but the difficult bit for us all is to make sure this change actually happens. There are challenges and opportunities for both us the regulator, and you the industry. It is a journey we have to walk together, as we put consumers back at the heart of what we do.

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Technical Specifications for the Solvency II valuation and Solvency Capital Requirements calculations (Part I) Note
This technical specification is a working document proposed by EIOPA to be used by insurance and reinsurance undertakings participating in any quantitative assessment to be undertaken until new update is available. As there are essential parts of the valuation framework still under political discussions, i.e. the discount rates for the technical provisions calculations, this document is not intended to be a complete set of technical specifications for the Solvency 2 balance sheet valuation nor for the Solvency Capital Requirements calculations. Howsoever these essential parts are not included at this stage but will follow in due course. Not even when the specification of discount rates for TP calculations are finally added, the resulting technical specifications should be seen as a complete implementation of the Solvency II framework, since for the purpose of feasibility of testing exercises, shortcuts and ad hoc simplifications have been included. In particular, relevant parts of the SCR calculation such as internal models section, undertaking specific parameters section and within the group section: the combination method, the treatment of Participations, Ring Fenced funds and internal model for group calculation have been deliberately not included in the current technical specifications, as these were not considered by EIOPA as providing key information for the purposes of the quantitative tests that may be launched in the coming months.

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However, this should not be interpreted as an EIOPA speculation on its inclusion in the final Solvency II framework. This technical specification is inspired by the knowledge that EIOPA has on the current status of the negotiations on Omnibus 2 Directive, the working documents on implementing measures and its own work in the development of Technical Standards and Guidelines. EIOPA plans to incorporate the relevant elements of the technical provisions valuation, once the outcome of the OMDII negotiations is stabilised.

Important parts IAS 39 Financial Instruments: Recognition and Measurement
IAS 39 establishes principles for recognising and measuring financial assets, financial liabilities and some contracts to buy or sell non-financial items. For the purpose of measuring a financial asset after initial recognition, this Standard classifies financial assets into the following four categories defined in paragraph 9: (a) Financial assets at fair value through profit or loss; (b) Held-to-maturity investments; (c) Loans and receivables; and (d) Available-for-sale financial assets. These categories apply to measurement and profit or loss recognition under this Standard. The entity may use other descriptors for these categories or other categorisations when presenting information in the financial statements.
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After initial recognition, an entity shall measure financial assets, including derivatives that are assets, at their fair values, without any deduction for transaction costs it may incur on sale or other disposal, except for the following financial assets: (a) Loans and receivables, which shall be measured at amortised cost using the effective interest method (b) Held-to-maturity investments, which shall be measured at amortised cost using the effective interest method (c) Investments in equity instruments that do not have a quoted market price in an active market and whose fair value cannot be reliably measured and derivatives that are linked to and must be settled by delivery of such unquoted equity instruments, which shall be measured at cost. Solvency II framework: Fair value measurement principles are considered to be consistent with article 75 of Directive 2009/138/EC, except for subsequent adjustments to take account of the change in own credit standing of the insurance or reinsurance undertaking after initial recognition in the measurement of financial liabilities.

Technical Provisions Introduction
TP.1.1. The reporting date to be used by all participants should be 30 June. TP.1.2. Solvency II requires undertakings to set up technical provisions which correspond to the current amount undertakings would have to pay if they were to transfer their (re)insurance obligations immediately to another undertaking.

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The value of technical provisions should be equal to the sum of a best estimate and a risk margin. However, under certain conditions that relate to the replicability of the cash flows underlying the (re)insurance obligations, best estimate and risk margin should not be valued separately but technical provisions should be calculated as a whole. TP.1.3. Undertakings should segment their (re)insurance obligations into homogeneous risk groups, and as a minimum by line of business, when calculating technical provisions TP.1.4. The best estimate should be calculated gross, without deduction of the amounts recoverable from reinsurance contracts and SPVs. Those amounts should be calculated separately. TP.1.5. The calculation of the technical provisions should take account of the time value of money by using the relevant risk-free interest rate term structure. TP.1.6. The actuarial and statistical methods to calculate technical provisions should be proportionate to the nature, scale and complexity of the risks supported by the undertaking.

V.2.1. Segmentation General principles
TP.1.7. Insurance and reinsurance obligations should be segmented as a minimum by line of business (LoB) in order to calculate technical provisions. TP.1.8. The purpose of segmentation of (re)insurance obligations is to achieve an accurate valuation of technical provisions. For example, in order to ensure that appropriate assumptions are used, it is important that the assumptions are based on homogenous data to
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avoid introducing distortions which might arise from combining dissimilar business. Therefore, business is usually managed in more granular homogeneous risk groups than the proposed minimum segmentation by lines of business where it allows for a more accurate valuation of technical provisions. TP.1.9. Undertakings in different Member States and even undertakings in the same Member State offer insurance products covering different sets of risks. Therefore it is appropriate for each undertaking to define the homogenous risk group and the level of granularity most appropriate for their business and in the manner needed to derive appropriate assumptions for the calculation of the best estimate. TP.1.10. (Re)insurance obligations should be allocated to the line of business that best reflects the nature of the risks relating to the obligation. In particular, the principle of substance over form should be followed for the allocation. In other words, the segmentation should reflect the nature of the risks underlying the contract (substance), rather than the legal form of the contract (form). TP.1.11. The segmentation into lines of business distinguishes between life and non-life insurance obligations. This distinction does not coincide with the legal distinction between life and non-life insurance activities or the legal distinction between life and non-life insurance contracts. Instead, the distinction between life and non-life insurance obligations should be based on the nature of the underlying risk: - Insurance obligations of business that is pursued on a similar technical basis to that of life insurance should be considered as life
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insurance obligations, even if they are non-life insurance from a legal perspective. - Insurance obligations of business that is not pursued on a similar technical basis to that of life insurance should be considered as nonlife insurance obligations, even if they are life insurance from a legal perspective. TP.1.12. In particular, annuities stemming from non-life insurance contracts (for example for motor vehicle liability insurance) are life insurance obligations. TP.1.13. The segmentation should be applied to both components of the technical provisions (best estimate and risk margin). It should also be applied where technical provisions are calculated as a whole.

Segmentation of non-life insurance and reinsurance obligations
TP.1.14. Non-life insurance obligations should be segmented into the following 12 lines of business:

Medical expenses insurance
This line of business includes obligations which cover the provision of preventive or curative medical treatment or care including medical treatment or care due to illness, accident, disability and infirmity, or financial compensation for such treatment or care, where the underlying business is not pursued on a similar technical basis to that of life insurance, other than obligations considered as workers' compensation insurance;

Income protection insurance
This line of business includes obligations which cover financial compensation in consequence of illness, accident, disability or infirmity where the underlying business is not pursued on a similar technical basis to that of life insurance, other than obligations considered as medical expenses or workers' compensation insurance;
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Workers’ compensation insurance
This line of business includes health insurance obligations which relate to accidents at work, industrial injury and occupational diseases and where the underlying business is not pursued on a similar technical basis to that of life insurance covering: - the provision of preventive or curative medical treatment or care relating to accident at work, industrial injury or occupational diseases; or - financial compensation for such treatment;
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or financial compensation for accident at work, industrial injury or occupational diseases;

Motor vehicle liability insurance
This line of business includes obligations which cover all liabilities arising out of the use of motor vehicles operating on land (including carrier’s liability);

Other motor insurance
This line of business includes obligations which cover all damage to or loss of land vehicles, (including railway rolling stock);

Marine, aviation and transport insurance
This line of business includes obligations which cover all damage or loss to river, canal, lake and sea vessels, aircraft, and damage to or loss of goods in transit or baggage irrespective of the form of transport. This line of business also includes all liabilities arising out of use of aircraft, ships, vessels or boats on the sea, lakes, rivers or canals (including carrier’s liability).
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Fire and other damage to property insurance
This line of business includes obligations which cover all damage to or loss of property other than motor, marine aviation and transport due to fire, explosion, natural forces including storm, hail or frost, nuclear energy, land subsidence and any event such as theft;

General liability insurance
This line of business includes obligations which cover all liabilities other than those included in motor vehicle liability and marine, aviation and transport;

Credit and suretyship insurance
This line of business includes obligations which cover insolvency, export credit, instalment credit, mortgages, agricultural credit and direct and indirect suretyship;

Legal expenses insurance
This line of business includes obligations which cover legal expenses and cost of litigation;

Assistance insurance
This line of business includes obligations which cover assistance for persons who get into difficulties while travelling, while away from home or while away from their habitual residence;

Miscellaneous financial loss insurance
This line of business includes obligations which cover employment risk, insufficiency of income, bad weather, loss of benefits, continuing general expenses, unforeseen trading expenses, loss of market value, loss of rent
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or revenue, indirect trading losses other than those mentioned before, other financial loss (not-trading) as well as any other risk of non-life insurance business not covered by the lines of business already mentioned. TP.1.15. Obligations relating to accepted proportional reinsurance should be segmented into 12 lines of business in the same way as nonlife insurance obligations are segmented. TP.1.16. Obligations relating to accepted non-proportional reinsurance in non-life should be segmented into 4 lines of business as follows: - Health: non-proportional reinsurance obligations relating to insurance obligations included in the following lines: medical expenses, income protection and workers’ compensation. - Property: non-proportional reinsurance obligations relating to insurance obligations included in the following lines: other motor insurance, fire and other damage to property, credit and suretyship, legal expenses, assistance, miscellaneous financial loss. Casualty: non-proportional reinsurance obligations relating to insurance obligations included in the following lines: motor vehicle liability and general liability. - Marine, aviation and transport: non-proportional reinsurance obligations relating to insurance obligations included in the line marine, aviation and transport insurance

Segmentation of life insurance and reinsurance obligations
TP.1.17. Life insurance obligations should be segmented into 6 lines of business.

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Health insurance
Health insurance obligations where the underlying business is pursued on a similar technical basis to that of life insurance, other than those included in the following line of business “Annuities stemming from non-life insurance contracts and relating to health insurance obligations”.

Life insurance with profit participation
Insurance obligations with profit participation other than those obligations included in the annuities stemming from non-life insurance contracts.

Index-linked and unit-linked insurance
Insurance obligations with index-linked and unit-linked benefits other than those included in the annuities stemming from non-life insurance.

Other life insurance
obligations other than obligations included in any of the other life lines of business. Annuities stemming from non-life insurance contracts and relating to health insurance obligations (annuities stemming from non-life contracts and NSLT health insurance). Annuities stemming from non-life insurance contracts and relating to insurance obligations other than health insurance obligations TP.1.18. Obligations relating to accepted reinsurance in life should be segmented into 4 lines of business as follows:

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Health reinsurance
Reinsurance obligations which relate to the obligations included in lines of business health insurance and “Annuities stemming from non-life insurance contracts and relating to health insurance obligations”.

Life reinsurance
Reinsurance obligations which relate to the obligations included in lines of business “Life Insurance with profit participation”, “Index-linked and unit-linked insurance”, “Other life insurance” and “Annuities stemming from non-life insurance contracts and relating to insurance obligations other than health insurance obligations”. TP.1.19. There could be circumstances where, for a particular line of business in the segment "life insurance with profit participation" (participating business), the insurance liabilities can, from the outset, not be calculated in isolation from those of the rest of the business. For example, an undertaking may have management rules such that bonus rates on one line of business can be reduced to recoup guaranteed costs on another line of business and/or where bonus rates depend on the overall solvency position of the undertaking. However, even in this case undertakings should assign a technical provision to each line of business in a practicable manner.

Health insurance obligations
TP.1.20. Health insurance covers one or both of the following: - The provision of preventive or curative medical treatment or care including medical treatment or care due to illness, accident, disability and infirmity, or financial compensation for such treatment or care;
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- Financial compensation in consequence of illness, accident, disability or infirmity. TP.1.21. In relation to their technical nature two types of health insurance can be distinguished: - Health insurance which is pursued on a similar technical basis to that of life insurance (SLT Health) - Health insurance which is not pursued on a similar technical basis to that of life insurance (Non-SLT Health) TP.1.22. Health insurance obligations pursued on a similar technical basis to that of life insurance (SLT Health) are the health insurance obligations for which it is appropriate to use life insurance techniques for the calculation of the best estimate. Health insurance obligations should be assigned to life insurance lines of business where such obligations are exposed to biometrical risks (i.e. mortality, longevity or disability/morbidity) and where the common techniques used to assess such obligations explicitly take into consideration the behaviour of the variables underlying these risks. Where insurance or reinsurance health obligations are calculated according to the conditions set out in Article 206 of Directive 2009/138/EPC they should be assigned to SLT health insurance lines of business. TP.1.23. SLT health insurance obligations should be allocated to one of the four following lines of business for life insurance obligations defined in subsection V .2.1: - Insurance contracts with profit participation where the main risk driver is disability/morbidity risk - Index-linked and unit-linked life insurance contracts where the main risk driver is disability/morbidity risk
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- Other insurance contracts where the main risk driver is disability/morbidity risk - Annuities stemming from non-life contracts. TP.1.24. With regard to the line of business for annuities stemming from non-life contracts or health insurance includes only annuities stemming from Non-SLT health contracts (for example workers' compensation and income protection insurance). Insurance or reinsurance obligations that, although stemming from Non-Life or NSLT health insurance, and originally segmented into NonLife or NSLT health lines of business, as a result of the trigger of an event are pursued on a similar technical basis to that of life insurance, should be assigned to the relevant life lines of business as soon as there is sufficient information to assess those obligations using life techniques. TP.1.25. Non-SLT health obligations should be allocated to one of the three following lines of business for non-life insurance obligations: - Medical expense - Income protection - Workers' compensation TP.1.26. The definition of health insurance applied in the Quantitative Assessment may not coincide with national definitions of health insurance used for authorisation or accounting purposes. TP.1.27. The granularity of the segmentation of insurance or reinsurance obligations should allow for an adequate reflection of the nature of the risks. For the purpose of calculation of the technical provisions, the segmentation should consider the policyholder’s right to profit participation, options and guarantees embedded in the contracts and the relevant risk drivers of the obligations.
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Unbundling of insurance and reinsurance contracts
TP.1.28. Where a contract includes life and non-life (re)insurance obligations, it should be unbundled into its life and non-life parts. TP.1.29. Where a contract covers risks across the different lines of business for non-life (re)insurance obligations, these contracts should be unbundled into the appropriate lines of business. TP.1.30. A contract covering life insurance risks should always be unbundled according to the following lines of business - SLT - Life insurance with profit participation - Index-linked and unit-linked life insurance - Other life insurance TP.1.31. Where a contract gives rise to SLT health insurance obligations, it should be unbundled into a health part and a non-health part where it is technically feasible and where both parts are material. Notwithstanding the above, unbundling may not be required where only one of the risks covered by a contract is material. In this case, the contract may be allocated according to the main risk.

Best estimate V.2.2.1. Methodology for the calculation of the best estimate Appropriate methodologies for the calculation of the best estimate
TP.2.1. The best estimate should correspond to the probability weighted average of future cash-flows taking account of the time value of money.

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TP.2.2. Therefore, the best estimate calculation should allow for the uncertainty in the future cash-flows. The calculation should consider the variability of the cash flows in order to ensure that the best estimate represents the mean of the distribution of cash flow values. Allowance for uncertainty does not suggest that additional margins should be included within the best estimate. TP.2.3. The best estimate is the average of the outcomes of all possible scenarios, weighted according to their respective probabilities. Although, in principle, all possible scenarios should be considered, it may not be necessary, or even possible, to explicitly incorporate all possible scenarios in the valuation of the liability, nor to develop explicit probability distributions in all cases, depending on the type of risks involved and the materiality of the expected financial effect of the scenarios under consideration. Moreover, it is sometimes possible to implicitly allow for all possible scenarios, for example in closed form solutions in life insurance or the chain-ladder technique in non-life insurance. TP.2.4. Cash-flow characteristics that should, in principle and where relevant, be taken into consideration in the application of the valuation technique include the following: a) Uncertainty in the timing, frequency and severity of claim events. b) Uncertainty in claims amounts, including uncertainty in claims inflation, and in the period needed to settle and pay claims. c) Uncertainty in the amount of expenses. d) Uncertainty in the expected future developments that will have a material impact on the cash in- and out-flows required to settle the insurance and reinsurance obligations thereof (e.g. the value of an index/market values used to determine claim amounts). For this purpose future developments shall include demographic, legal, medical, technological, social, environmental and economic developments including inflation.
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e) Uncertainty in policyholder behaviour. f) Path dependency, where the cash-flows depend not only on circumstances such as economic conditions on the cash-flow date, but also on those circumstances at previous dates. A cash-flow having no path dependency can be valued by, for example, using an assumed value of the equity market at a future point in time. However, a cash-flow with path-dependency would need additional assumptions as to how the level of the equity market evolved (the equity market's path) over time in order to be valued. g) Interdependency between two or more causes of uncertainty. Some risk-drivers may be heavily influenced by or even determined by several other risk-drivers (interdependence). For example, a fall in market values may influence the (re)insurance undertaking’s exercise of discretion in future participation, which in turn affects policyholder behaviour. Another example would be a change in the legal environment or the onset of a recession which could increase the frequency or severity of non-life claims. TP.2.5. Undertakings should use actuarial and statistical techniques for the calculation of the best estimate which appropriately reflect the risks that affect the cash-flows. This may include simulation methods, deterministic techniques and analytical techniques. TP.2.6. For certain life insurance liabilities, in particular the future discretionary benefits relating to participating contracts or other contracts with embedded options and guarantees, simulation may lead to a more appropriate and robust valuation of the best estimate liability.
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TP.2.7. For the estimation of non-life best estimate liabilities as well as life insurance liabilities that do not need simulation techniques, deterministic and analytical techniques can be more appropriate.

Cash-flow projections
TP.2.8. The best estimate should be calculated gross, without deduction of the amounts recoverable from reinsurance contracts and special purpose vehicles. Recoverables from reinsurance and Special Purpose Vehicles should be calculated separately. In the case of co-insurance the cash-flows of each co-insurer should be calculated as their proportion of the expected cash-flows without deduction of the amounts recoverable from reinsurance and special purpose vehicles. TP.2.9. Cash-flow projections should reflect expected realistic future demographic, legal, medical, technological, social or economic developments. TP.2.10. Appropriate assumptions for future inflation should be built into the cash-flow projection. Care should be taken to identify the type of inflation to which particular cash-flows are exposed (i.e. consumer price index, salary inflation). TP.2.11. The cash-flow projections, in particular for health insurance business, should take account of claims inflation and any premium adjustment clauses. It may be assumed that the effects of claims inflation and premium adjustment clauses cancel each other out in the cash flow projection, provided this approach undervalues neither the best estimate, nor the risk involved with the higher cash flows after claims inflation and premium adjustment.

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Recognition and derecognition of (re)insurance contracts for solvency purposes
TP.2.12. The calculation of the best estimate should only include future cash-flows associated with obligations within the boundary of the contract. TP.2.13. A reinsurance or insurance obligation should be initially recognised by insurance or reinsurance undertakings at whichever is the earlier of the date the undertaking becomes a party to the contract that gives rise to the obligation or the date the insurance or reinsurance cover begins. TP.2.14. A contract should be derecognised as an existing contract only when the obligation specified in the contract is extinguished, discharged or cancelled or expires.

The boundary of an existing (re)insurance contract
TP.2.15. The definition of the contract boundary should be applied in particular to decide whether options to renew the contract, to extend the insurance coverage to another person, to extend the insurance period, to increase the insurance cover or to establish additional insurance cover gives rise to a new contract or belongs to the existing contract. Where the option belongs to the existing contract the provisions for policyholder options should be taken into account. TP.2.16. For the purpose of determining which insurance or reinsurance obligations arise in relation to an insurance or reinsurance contract, the boundaries of the contract shall be defined in the following manner: (a) Where the insurance or reinsurance undertaking has at a future date: (i) A unilateral right to terminate the contract, (ii) A unilateral right to reject premiums payable under the contract, or (iii) A unilateral right to amend the premiums or the benefits payable under the contract in such a way that the premiums fully reflect the risks,
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any obligations which relate to insurance or reinsurance cover which might be provided by the undertaking after that date do not belong to the contract, unless the undertaking can compel the policy holder to pay the premium for those obligations; (b) Where the insurance or reinsurance undertaking has a unilateral right as referred to in point (a) that relates only to a part of the contract, the same principle as defined in point (a) shall be applied to this part; (c) Notwithstanding points (a) and (b), where an insurance or reinsurance contract: (i) Does not provide compensation for a specified uncertain event that adversely affects the insured person, (ii) Does not include a financial guarantee of benefits, any obligations that do not relate to premiums which have already been paid do not belong to the contract, unless the undertaking can compel the policy holder to pay the future premium; (d) Notwithstanding points (a) and (b), where an insurance or reinsurance contract can be unbundled into two parts and where one of these parts meets the requirements set out in points (c)(i) and (ii), any obligations that do not relate to the premiums of that part and which have already been paid do not belong to the contract, unless the undertaking can compel the policy holder to pay future premium of that part; (e) All other obligations relating to the contract, including obligations relating to unilateral rights of the insurance or reinsurance undertaking to renew or extend the scope of the contract and obligations that relate to paid premiums, belong to the contract. TP.2.17. Where an insurance or reinsurance undertaking has the unilateral right to amend the premiums or benefits of a portfolio of insurance or reinsurance obligations in such a way that the premiums of the portfolio fully reflect the risks covered by the portfolio, the undertaking's unilateral right to amend the premiums or benefits of those obligations shall be regarded as complying with the condition set out in paragraph TP.2.16(a).
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TP.2.18. Premiums shall be regarded as fully reflecting the risks covered by a portfolio of insurance or reinsurance obligations, only where there is no scenario under which the amount of the benefits and expenses payable under the portfolio exceeds the amount of the premiums payable under the portfolio; TP.2.19. Notwithstanding paragraph TP.2.17, in the case of life insurance obligations where an individual risk assessment of the obligations relating to the insured person of the contract is carried out at the inception of the contract and that assessment cannot be repeated before amending the premiums or benefits, the assessment of whether the premiums fully reflect the risk in accordance with the condition set out in paragraph 1(a) shall be made at the level of the contract. TP.2.20. For the purpose of points (a) and (b) of paragraph TP.2.16, restrictions of the unilateral right and limitations of the extent by which premiums and benefits can be amended that have no discernible effect on the economics of the contract, shall be ignored. TP.2.21. For the purpose of points (c) and (d) of paragraph TP.2.16, coverage of events and guarantees that have no discernible effect on the economics of the contract, shall be ignored. TP.2.22. Annex D includes several examples that illustrate the application of the definition of the contract boundary.

Time horizon
TP.2.23. The projection horizon used in the calculation of best estimate should cover the full lifetime of all the cash in- and out-flows required to settle the obligations related to existing insurance and reinsurance contracts on the date of the valuation, unless an accurate valuation can be achieved otherwise. TP.2.24. The determination of the lifetime of insurance and reinsurance obligations should be based on up-to-date and credible information and realistic assumptions about when the existing insurance and reinsurance obligations will be discharged or cancelled or expired.
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Gross cash in-flows
TP.2.25. To determine the best estimate the following non-exhaustive list of cash in-flows should be included: - Future premiums; and - Receivables for salvage and subrogation. TP.2.26. The cash in-flows should not take into account investment returns (i.e. interests earned, dividends…).

Gross cash out-flows
TP.2.27. The cash out-flows could be divided between benefits to the policyholders or beneficiaries, expenses that will be incurred in servicing insurance and reinsurance obligations, and other cash-flow items such as taxation payments which are charged to policyholders.

Benefits
TP.2.28. The benefit cash out-flows (non-exhaustive list) should include: Claims payments Maturity benefits Death benefits Disability benefits Surrender benefits Annuity payments Profit sharing bonuses

Expenses
TP.2.29. In determining the best estimate, the undertaking should take into account all cash-flows arising from expenses that will be incurred in servicing all recognised insurance and reinsurance obligations over the lifetime thereof. This should include (non-exhaustive list):
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- Administrative expenses - Investment management expenses - Claims management expenses / handling expenses TP.2.30. Expenses that are pertinent to the valuation of technical provisions would usually include both allocated and overhead expenses. Allocated expenses are those expenses which could be directly assignable to the source of expense that will be incurred in servicing insurance and reinsurance obligations. Overhead expenses comprise all other expenses which the undertaking incurs in servicing insurance and reinsurance obligations. TP.2.31. Overhead expenses include, for example, expenses which are related to general management and service departments which are not directly involved in new business or policy maintenance activities and which are insensitive to either the volume of new business or the level of in-force business. The allocation of overhead expenses to homogeneous risk groups or the premium provisions and the provisions for claims outstanding shall be done in a realistic and objective manner and on a consistent basis over time. The same requirements shall apply to the allocation of overhead expenses to existing and future business. TP.2.32. Administrative expenses are expenses which are connected with policy administration including expenses in respect of reinsurance contracts and special purpose vehicles. Some administrative expenses relate directly to insurance contract or contract activity (e.g. maintenance cost) such as cost of premium billing, cost of sending regular information to policyholders and cost of handling policy changes (e.g. conversions and reinstatements).
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Other administrative expenses relate directly to insurance contracts or contract activity but are a result of activities that cover more than one policy such as salaries of staff responsible for policy administration. TP.2.33. Investment management expenses are usually not allocated on a policy by policy basis but at the level of a portfolio of insurance contracts. Investment management expenses could include expenses of recordkeeping of the investments’ portfolio, salaries of staff responsible for investment, remunerations of external advisers, expenses connected with investment trading activity (i.e. buying and selling of the portfolio securities) and in some cases also remuneration for custodial services. Investment management expenses have to be based on a portfolio of assets appropriate to cover their portfolio of obligations. In case the future discretionary benefits depend on the assets held by the undertaking and for unit-linked contracts the undertaking should ensure that the future investment management expenses allow for the expected changes to the future aforementioned portfolio of assets. In particular, a dynamic expense allowance should be used to reflect a dynamic asset strategy. TP.2.34. Usually investment management expenses differ regarding different assets classes. To ensure that investment management expenses will properly reflect the characteristics of the portfolio, investment management expenses in relation to different assets will be based on existing and predicted future split of assets. TP.2.35. Investment management expenses are considered as cash outflow in the calculation of the best estimate since discounting is made with a yield curve gross of investment expenses.
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TP.2.36. Claims management expenses are expenses that will be incurred in processing and resolving claims, including legal and adjuster’s fees and internal costs of processing claims payments. Some of these expenses could be assignable to individual claim (e.g. legal and adjuster’s fees), others are a result of activities that cover more than one claim (e.g. salaries of staff of claims handling department). TP.2.37. Acquisition expenses include expenses which can be identified at the level of individual insurance contract and have been incurred because the undertaking has issued that particular contract. These are commission costs, costs of selling, underwriting and initiating an insurance contract that has been issued. TP.2.38. Overhead expenses include salaries to general managers, auditing costs and regular day-to-day costs i.e. electricity bill, rent for accommodations, IT costs. These overhead expenses also include expenses related to the development of new insurance and reinsurance business, advertising insurance products, improvement of the internal processes such as investment in system required to support insurance and reinsurance business (e.g. buying new IT system and developing new software). TP.2.39. Expenses connected with activities which are not linked with servicing insurance and reinsurance obligations are not taken into account when calculating technical provisions. Such expenses could be for example company pension scheme deficits, holding companies’ operational expenses connected with expenses linked to entities which are not insurance or reinsurance undertakings. TP.2.40. Undertakings should value and take into account charges for embedded options in the valuation of the technical provisions where possible.
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For life insurance contracts with embedded options it is rather common that for the cost of the embedded option only a minor charge is made up front and that the remainder is due in an extended period of time. This does not necessarily have to be the total time until maturity and is in general not necessary fixed or known exactly in advance. Charges from embedded options are taken into account in the best estimate valuation of technical provisions and they are kept separately from expense loadings. For example a surrender charge could possibly be seen as a charge to offset the uncollected charges in average, but could also be seen as a way to force the policyholder to continue the contract and hence it would not directly be related to the cost of embedded options. TP.2.41. To the extent that future premiums from existing insurance and reinsurance contracts are taken into account in the valuation of the best estimate, expenses relating to these future premiums should be taken into consideration. TP.2.42. Undertaking should consider their own analysis of expenses and any relevant data from external sources such as average industry or market data. Undertakings should assess the availability of market data on expenses by considering the representativeness of the market data relative to the portfolio and the credibility and reliability of the data. TP.2.43. Where average market information is used, consideration needs to be given as to the representativeness of the data used to form that average. For example, market information is not deemed to be sufficiently representative where the market information has material dispersion in representativeness of the portfolios whose data have been used to calculate such market information.
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The assessment of credibility considers the volume of data underlying the market information. TP.2.44. Assumptions with respect to future expenses arising from commitments made on or prior to the date of valuation have to be appropriate and take into account the type of expenses involved. Undertakings should ensure that expense assumptions allow for future changes in expenses and such an allowance for inflation is consistent with the economic assumptions made. Future expense cash flows are usually assumed to vary with assumed rates of general level of expense inflation in a reasonable manner. TP.2.45. Relevant market data needs to be used to determine expense assumptions which include an allowance for future cost increase. The correlation between inflation rates and interest rates are taken into account. An undertaking needs to ensure that the allowance for inflation is consistent with the economic assumptions made, which could be achieved if the probabilities for each inflation scenario are consistent with probabilities implied by market interest rates. Furthermore, expense inflation must be consistent with the types of expenses being considered (e.g. different levels of inflation would be expected regarding office space rents, salaries of different types of staff, IT systems, medical expenses, etc.). TP.2.46. Any assumptions about the expected cost reduction should be realistic, objective and based on verifiable data and information. TP.2.47. For the assessment of the future expenses, undertakings should take into account all the expenses that are directly related to the ongoing administration of obligations related to existing insurance and
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reinsurance contracts, together with a share of the relevant overhead expenses. The share of overheads should be assessed on the basis that the undertaking continues to write further new business. Overhead expenses have to be apportioned between existing and future business based on recent analyses of the operations of the business and the identification of appropriate expense drivers and relevant expense apportionment ratios. Cash flow projections should include, as cash out-flows, the recurrent overheads attributable to the existing business at the calculation date of the best estimate. TP.2.48. In order to determine which expenses best reflect the characteristics of the underlying portfolio and to ensure that the technical provisions are calculated in a prudent, reliable and objective manner, insurance and reinsurance undertakings should consider the appropriateness of both market consistent expenses and undertaking specific expenses. If sufficiently reliable, market consistent expenses are not available participants should use undertaking-specific information to determine expenses that will be incurred in servicing insurance and reinsurance obligations provided that the undertaking-specific information is assessed to be appropriate. TP.2.49. Expenses, that are determined by contracts between the undertaking and third parties have to be taken into account based on the terms of the contract. In particular, commissions arising from insurance contracts have to be considered based on the terms of the contracts between the undertakings and the sales persons, and expenses in respect of reinsurance are taken into account based on the contracts between the undertaking and its reinsurers.
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Tax payments
TP.2.50. In determining the best estimate, undertakings should take into account taxation payments which are charged to policyholders. Only those taxation payments which are settled by the undertaking need to be taken into account. A gross calculation of the amounts due to policyholders suffices where tax payments are settled by the policyholders; TP.2.51. Different taxation regimes exist across Member States giving rise to a broad variety of tax rules in relation to insurance contracts. The assessment of the expected cash-flows underlying the technical provisions should take into account any taxation payments which are charged to policyholders, or which would be required to be made by the undertaking to settle the insurance obligations. All other tax payments should be taken into account under other balance sheet items. TP.2.52. The following tax payments should be included in the best estimate: transaction-based taxes (such as premium taxes, value added taxes and goods and services taxes) and levies (such as fire service levies and guarantee fund assessments) that arise directly from existing insurance contracts, or that can be attributed to the contracts on a reasonable and consistent basis. Contributions which were already included in companies’ expense assumptions (i.e. levies paid by insurance companies to industry protection schemes) should not be included. TP.2.53. The allowance for tax payments in the best estimate should be consistent with the amount and timing of the taxable profits and losses that are expected to be incurred in the future. In cases where changes to taxation requirements are substantially enacted, the pending adjustments should be reflected.
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TP.2.54. Homogeneous risk groups of life insurance obligations
The cash-flow projections used in the calculation of best estimates for life insurance obligations shall be made separately for each policy. Where the separate calculation for each policy would be an undue burden on the insurance or reinsurance undertaking, it may carry out the projection by grouping policies, provided that the grouping complies with the following requirements: (1) There are no significant differences in the nature and complexity of the risks underlying the policies that belong to the same group; (2) The grouping of policies does not misrepresent the risk underlying the policies and does not misstate their expenses; (3) The grouping of policies is likely to give approximately the same results for the best estimate calculation as a calculation on a per policy basis, in particular in relation to financial guarantees and contractual options included in the policies. TP.2.55. In certain specific circumstances, the best estimate element of technical provisions may be negative (e.g. for some individual contracts). This is acceptable and undertakings should not set to zero the value of the best estimate with respect to those individual contracts. TP.2.56. No implicit or explicit surrender value floor should be assumed for the amount of the market consistent value of liabilities for a contract. This means that if the sum of a best estimate and a risk margin of a contract is lower than the surrender value of that contract there is no need to increase the value of insurance liabilities to the surrender value of the contract.

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Non-life insurance obligations
TP.2.57. The valuation of the best estimate for provisions for claims outstanding and for premium provisions should be carried out separately. With respect to the best estimate for premium provisions, the cash-flow projections relate to claim events occurring after the valuation date and during the remaining in-force period (coverage period) of the policies held by the undertaking (existing policies). The cash-flow projections should comprise all future claim payments and claims administration expenses arising from these events, cashflows arising from the ongoing administration of the in-force policies and expected future premiums stemming from existing policies. TP.2.58. The best estimate of premium provisions from existing insurance and reinsurance contracts should be given as the expected present value of future in- and out-going cash-flows, being a combination of, inter alia: - cash-flows from future premiums; - cash-flows resulting from future claims events; - cash-flows arising from allocated and unallocated claims administration expenses; - cash-flows arising from ongoing administration of the in-force policies. There is no need for the listed items to be calculated separately. TP.2.59. With regard to premium provisions, the cash in-flows could exceed the cash out-flows leading to a negative best estimate.
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This is acceptable and undertakings are not required to set to zero the value of the best estimate. The valuation should take account of the time value of money where risks in the remaining period would give rise to claims settlements into the future. TP.2.60. Additionally, the valuation of premium provisions should take account of future policyholder behaviour such as likelihood of policy lapse during the remaining period. TP.2.61. With respect to the best estimate for provisions for claims outstanding, the cash-flow projections relate to claim events having occurred before or at the valuation date – whether the claims arising from these events have been reported or not (i.e. all incurred but not settled claims). The cash-flow projections should comprise all future claim payments as well as claims administration expenses arising from these events. TP.2.62. Where non-life insurance policies give rise to the payment of annuities, the approach laid down in the following subsection on substance over form should be followed. Consistent with this, for premium provisions, its assessment should include an appropriate calculation of annuity obligations if a material amount of incurred claims is expected to give rise to the payment of annuities.

Principle of substance over form
TP.2.63. When discussing valuation techniques for calculating technical provisions, it is common to refer to a distinction between a valuation based on life techniques and a valuation based on non-life techniques.

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The distinctions between life and non-life techniques are aimed towards the nature of the liabilities (substance), which may not necessarily match the legal form (form) of the contract that originated the liability. The choice between life or non-life actuarial methodologies should be based on the nature of the liabilities being valued and from the identification of risks which materially affect the underlying cash-flows. This is the essence of the principle of substance over form. TP.2.64. Traditional life actuarial techniques to calculate the best estimate can be described as techniques that are based on discounted cash-flow models, generally applied on a policy-by-policy basis, which take into account in an explicit manner risk factors such as mortality, survival and changes in the health status of the insured person(s). TP.2.65. On the other hand, traditional non-life actuarial techniques include a number of different approaches. For example some of the most common being: - Methodologies based on the projection of run-off triangles, usually constructed on an aggregate basis; - Frequency/severity models, where the number of claims and the severity of each claim is assessed separately; - Methodologies based on the estimation of the expected loss ratio or other relevant ratios; - Combinations of the previous methodologies; TP.2.66. There is one key difference between life and non-life actuarial methodologies: life actuarial methodologies consider explicitly the probabilities of death, survival, disability and/or morbidity of the insured persons as key parameters in the model, while non-life actuarial methodologies do not.
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TP.2.67. The choice between life or non-life actuarial methodologies should be based on the nature of the liabilities valued and on the identification of risks which materially affect the underlying cash-flows. TP.2.68. In practice, in the majority of cases the form will correspond to the substance. However, for example for certain supplementary covers included in life contracts (e.g. accident) may be better suited for an estimation based on non-life actuarial methodologies. TP.2.69. The following provides additional guidance for the treatment of annuities arising in non-life insurance. The application of the principle of substance over form implies that such liabilities should be valued using methodologies usually applicable to the valuation of life technical provisions, Specifically, guidance is provided in relation to: - the recognition and segmentation of insurance obligations for the purpose of calculating technical provisions (i.e. the allocation of obligations to the individual lines of business); - the valuation of technical provisions for such annuities; and - possible methods for the valuation of technical provisions for the remaining non-life obligations TP.2.70. The treatment proposed in these specifications for annuities should be extended to other types of liabilities stemming from non-life and health insurance whose nature is deemed similar to life liabilities (such as life assistance benefits), taking into consideration the principle mentioned in the previous paragraph.

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Allocation to the individual lines of business
TP.2.71. Where non-life and Non-SLT health insurance policies give rise to the payment of annuities such liabilities should be valued using techniques commonly used to value life insurance obligations. Such liabilities should be assigned to the lines of business for annuities stemming from non-life contracts.

Valuation of annuities arising from non-life and Non-SLT health insurance contracts
TP.2.72. Undertakings should value the technical provisions related to such annuities separately from the technical provisions related to the remaining non-life and health obligations. They should apply appropriate life insurance valuation techniques. The valuation should be consistent with the valuation of life insurance annuities with comparable technical features.

Valuation of the remaining non-life and health insurance obligations
TP.2.73. The remaining obligations in the undertaking’s non-life and Non-SLT health business (which are similar in nature to non-life insurance obligations) have to be valued separately from the relevant block of annuities. TP.2.74. Where provisions for claims outstanding according to national accounting rules are compared to provisions for claims outstanding as calculated above, it should be taken into account that the latter do not include the annuity obligations. TP.2.75. Undertakings may use, where appropriate, one of the following approaches to determine the best estimate of claims provisions for the remaining non-life or health obligations in a given non-life or Non-SLT health insurance line of business where annuities are valued separately.
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Separate calculation of non-life liabilities
TP.2.76. Under this approach, the run-off triangle which is used as a basis for the determination of the technical provisions should not include any cash-flows relating to the annuities. An additional estimate of the amount of annuities not yet reported and for reported but not yet agreed annuities needs to be added.

Allowance of agreed annuities as single lump-sum payments in the run-off triangle
TP.2.77. This approach also foresees a separate calculation of the best estimate, where the split is between annuities in payment and the remaining obligations. TP.2.78. Under this approach, the run-off triangle which is used as a basis for the determination of the technical provisions of the remaining non-life or health obligations in a line of business does not include any cash-flows relating to the annuities in payment. This means that claims payments for annuities in payment are excluded from the run-off triangle. TP.2.79. However, payments on claims before annuitisation1 and payments at the time of annuitisation remain included in the run-off triangle. At the time of annuitisation, the best estimate of the annuity (valued separately according to life principles) is shown as a single lump-sum payment in the run-off triangle, calculated as at the date of the annuitisation. Where proportionate, approximations of the lump sums could be used.
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TP.2.80. Where the analysis is based on run-off triangles of incurred claims, the lump sum payment should reduce the case reserves at the date of annuitisation. TP.2.81. On basis of run-off triangles adjusted as described above, the participant may apply an appropriate actuarial reserving method to derive a best estimate of the claims provision of the portfolio. Due to the construction of the run-off triangle, this best estimate would not include the best estimate related to the annuities in payment which would be valued separately using life principles (i.e. there would be no “double counting” in relation to the separate life insurance valuation), but it includes a best estimate for not yet reported and for reported but not yet agreed annuities.

Expert judgement
TP.2.82. Insurance and reinsurance undertakings shall choose assumptions based on the expertise of persons with relevant knowledge, experience and understanding of the risks inherent in the insurance or reinsurance business thereof (expert judgment). In certain circumstances expert judgement may be necessary when calculating the best estimate, among other: - in selecting the data to use, correcting its errors and deciding the treatment of outliers or extreme events, - in adjusting the data to reflect current or future conditions, and adjusting external data to reflect the undertaking’s features or the characteristics of the relevant portfolio, - in selecting the time period of the data - in selecting realistic assumptions
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- in selecting the valuation technique or choosing the most appropriate alternatives existing in each methodology - in incorporating appropriately to the calculations the environment under which the undertakings have to run its business. TP.2.83. In the case of non-life insurance and non-life reinsurance obligations, participants should allocate the expenses into homogenous risk groups, as a minimum by line of business according to the segmentation of their obligations used in the calculation of technical provisions. Undertakings should allocate the expenses of non-life insurance and reinsurance obligations to premium provisions and to provisions for claims outstanding.

Obligations in different currencies
TP.2.84. The probability-weighted average cash-flows should take into account the time value of money. The time value of money of future cash-flows in different currencies is calculated using risk-free term structure for relevant currency. Therefore the best estimate should be calculated separately for obligations of different currencies.

Valuation of options and guarantees embedded in insurance contracts
TP.2.85. When calculating the best estimate, insurance and reinsurance undertakings shall identify and take into account: 1. All financial guarantees and contractual options included in their insurance and reinsurance policies;
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2. All factors which may materially affect the likelihood that policy holders will exercise contractual options or the value of the option or guarantee.

Definition of contractual options and financial guarantees
TP.2.86. A contractual option is defined as a right to change the benefits2, to be taken at the choice of its holder (generally the policyholder), on terms that are established in advance. Thus, in order to trigger an option, a deliberate decision of its holder is necessary. TP.2.87. Some (non-exhaustive) examples of contractual options which are pre-determined in contract and do not require again the consent of the parties to renew or modify the contract include the following: - Surrender value option, where the policyholder has the right to fully or partially surrender the policy and receive a pre-defined lump sum amount; - Paid-up policy option, where the policyholder has the right to stop paying premiums and change the policy to a paid-up status; - Annuity conversion option, where the policyholder has the right to convert a lump survival benefit into an annuity at a pre-defined minimum rate of conversion; - Policy conversion option, where the policyholder has the right to convert from one policy to another at pre-specific terms and conditions; - Extended coverage option, where the policyholder has the right to extend the coverage period at the expiry of the original contract without producing further evidence of health.

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TP.2.88. A financial guarantee is present when there is the possibility to pass losses to the undertaking or to receive additional benefits as a result of the evolution of financial variables (solely or in conjunction with nonfinancial variables) (e.g. investment return of the underlying asset portfolio, performance of indices, etc.). In the case of guarantees, the trigger is generally automatic (the mechanism would be set in the policy’s terms and conditions) and thus not dependent on a deliberate decision of the policyholder / beneficiary. In financial terms, a guarantee is linked to option valuation. TP.2.89. The following is a non-exhaustive list of examples of common financial guarantees embedded in life insurance contracts: - Guaranteed invested capital - Guaranteed minimum investment return - Profit sharing TP.2.90. There are also non-financial guarantees, where the benefits provided would be driven by the evolution of non-financial variables, such as reinstatement premiums in reinsurance, experience adjustments to future premiums following a favourable underwriting history (e.g. guaranteed no-claims discount). Where these guarantees are material, the calculation of technical provisions should also take into account their value.

Valuation requirements
TP.2.91. For each type of contractual option insurers are required to identify the risk drivers which have the potential to materially affect (directly or indirectly) the frequency of option take-up rates considering a sufficiently large range of scenarios, including adverse ones.
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TP.2.92. The best estimate of contractual options and financial guarantees must capture the uncertainty of cash-flows, taking into account the likelihood and severity of outcomes from multiple scenarios combining the relevant risk drivers. TP.2.93. The best estimate of contractual options and financial guarantees should reflect both the intrinsic value and the time value. TP.2.94. The best estimate of contractual options and financial guarantees may be valued by using one or more of the following methodologies: - A stochastic approach using for instance a market-consistent asset model (includes both closed form and stochastic simulation approaches); - A series of deterministic projections with attributed probabilities; and - A deterministic valuation based on expected cash-flows in cases where this delivers a market-consistent valuation of the technical provision, including the cost of options and guarantees. TP.2.95. For the purposes of valuing the best estimate of contractual options and financial guarantees, a stochastic simulation approach would consist of an appropriate market-consistent asset model for projections of asset prices and returns (such as equity prices, fixed interest rate and property returns), together with a dynamic model incorporating the corresponding value of liabilities (incorporating the stochastic nature of any relevant non-financial risk drivers) and the impact of any foreseeable actions to be taken by management. TP.2.96. For the purposes of the deterministic approach, a range of scenarios or outcomes appropriate to both valuing the options or guarantees and the underlying asset mix, together with the associated probability of occurrence should be set.
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These probabilities of occurrence should be weighted towards adverse scenarios to reflect market pricing for risk. The series of deterministic projections should be numerous enough to capture a wide range of possible out-comes (and, in particular, it should include very adverse yet possible scenarios) and take into account the probability of each outcome's likelihood (which may, in practice, need to incorporate judgement). The costs will be understated if only relatively benign or limited economic scenarios are considered. TP.2.97. When the valuation of the best estimate of contractual options and financial guarantees is not being done on a policy-by-policy basis, the segmentation considered should not distort the valuation of technical provisions by, for example, forming groups containing policies which are "in the money" and policies which are "out of the money". TP.2.98. Regarding contractual options, the assumptions on policyholder behaviour should be appropriately founded in statistical and empirical evidence, to the extent that it is deemed representative of the future expected behaviour. However, when assessing the experience of policyholders’ behaviour appropriate attention based on expert judgements should be given to the fact that when an option is out of or barely in the money, the behaviour of policyholders should not be considered to be a reliable indication of likely policyholders’ behaviour when the options are heavily in-themoney. TP.2.99. Appropriate consideration should also be given to an increasing future awareness of policy options as well as policyholders’ possible reactions to a changed financial position of an undertaking. In general, policyholders’ behaviour should not be assumed to be independent of financial markets, a firm’s treatment of customers or
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publicly available information unless proper evidence to support the assumption can be observed. TP.2.100. Where material, non-financial guarantees should be treated like financial guarantees.

Valuation of future discretionary benefits
TP.2.101. In calculating the best estimate, undertakings should take into account future discretionary benefits which are expected to be made, whether or not those payments are contractually guaranteed. Undertakings should not take into account payments that relate to surplus funds which possess the characteristics of Tier 1 basic own funds. Surplus funds are accumulated profits which have not been made available for distribution to policyholders and beneficiaries. (Cf. Article 91 of the Solvency II Framework Directive.) TP.2.102. When undertakings calculate the best estimate of technical provisions, the value of future discretionary benefits should be calculated separately. TP.2.103. Future discretionary benefits means benefits of insurance or reinsurance contracts which have one of the following characteristics: - The benefits are legally or contractually based on one or several of the following results: - The performance of a specified pool of contracts or a specified type of contract or a single contract; - Realised or unrealised investment return on a specified pool of assets held by the insurance or reinsurance undertaking; - The profit or loss of the insurance or reinsurance undertaking or fund that issues the contract that gives rise to the benefits;
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- The benefits are based on a declaration of the insurance or reinsurance undertaking and the timing or the amount of the benefits is at its discretion. TP.2.104. Index-linked and unit-linked benefits should not be considered as discretionary benefits. TP.2.105. The distribution of future discretionary benefits is a management action and assumptions about it should be objective, realistic and verifiable. In particular assumptions about the distribution of future discretionary benefits should take the relevant and material characteristics of the mechanism for their distribution into account. TP.2.106. Some examples of characteristics of mechanisms for distributing discretionary benefits are the following. Undertakings should consider whether they are relevant and material for the valuation of future discretionary benefits and take them into account accordingly, applying the principle of proportionality. - What constitutes a homogenous group of policyholders and what are the key drivers for the grouping? - How is a profit divided between owners of the undertaking and the policyholders and furthermore between different policyholders? - How is a deficit divided between owners of the undertaking and the policyholders and furthermore between different policyholders? - How will the mechanism for discretionary benefits be affected by a large profit or loss? - How will policyholders be affected by profits and losses from other activities?
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- What is the target return level set by the firm’s owners on their invested capital? - What are the key drivers affecting the level of discretionary benefits? - What is an expected level (inclusive of any distribution of excess capital, unrealised gains etc.) of discretionary benefits? - How are the discretionary benefits made available for policyholders and what are the key drivers affecting for example the split between reversionary and terminal discretionary benefits, conditionality, changes in smoothing practice, level of discretionary by the undertaking, etc. - How will the experience from current and previous years affect the level of discretionary benefits? - When is an undertaking's solvency position so weak that declaring discretionary benefits is considered by the undertaking to jeopardize a shareholder’s or/and policyholders’ interest? - What other restrictions are in place for determining the level of discretionary benefits? - What is an undertaking's investment strategy? - What is the asset mix driving the investment return? - What is the smoothing mechanism if used and what is the interplay with a large profit or loss? - What kind of restrictions are in place in smoothing extra benefits? - Under what circumstances would one expect significant changes in the crediting mechanism for discretionary benefits? - To what extent is the crediting mechanism for discretionary benefits sensitive to policyholders’ actions?
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TP.2.107. Where the future discretionary benefits depend on the assets held by the undertaking, the calculation of the best estimate should be based on the current assets held by the undertaking. Future changes of the asset allocation should be taken into account according to the requirements on future management actions. TP.2.108. The assumptions on the future returns of these assets, valued according to the subsection V.1, should be consistent with the relevant risk-free interest term structure for the Quantitative Assessment. Where a risk neutral approach for the valuation is used, the set of assumptions on returns of future investments underlying the valuation of discretionary benefits should be consistent with the principle that they should not exceed the level given by the forward rates derived from the risk-free interest rates.

Assumptions underlying the calculation of the best estimate Assumptions consistent with information provided by financial markets
TP.2.109. Assumptions consistent with information about or provided by financial markets include (non-exhaustive list): - relevant risk-free interest rate term structure, - currency exchange rates, - market inflation rates (consumer price index or sector inflation) and - economic scenario files (ESF). TP.2.110. When undertakings derive assumptions on future financial market parameters or scenarios, they should be able to demonstrate that
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the choice of the assumptions is appropriate and consistent with the valuation principles set out in subsection V.1; TP.2.111. Where the undertaking uses a model to produce future projections of market parameters (market consistent asset model, e.g. an economic scenario file), such model should comply with the following requirements: i. It generates asset prices that are consistent with deep, liquid and transparent financial markets 4; ii. It assumes no arbitrage opportunity; TP.2.112. The following principles should be taken into account in determining the appropriate calibration of a market consistent asset model: a) The asset model should be calibrated to reflect the nature and term of the liabilities, in particular of those liabilities giving rise to significant guarantee and option costs. b) The asset model should be calibrated to the current risk-free term structure used to discount the cash flows. c) The asset model should be calibrated to a properly calibrated volatility measure. TP.2.113. In principle, the calibration process should use market prices only from financial markets that are deep, liquid and transparent. If the derivation of a parameter is not possible by means of prices from deep, liquid and transparent markets, other market prices may be used. In this case, particular attention should be paid to any distortions of the market prices.
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Corrections for the distortions should be made in a deliberate, objective and reliable manner. TP.2.114. A financial market is deep, liquid and transparent, if it meets the requirements specified in the subsection of these specifications regarding circumstances in which technical provisions should be calculated as a whole. TP.2.115. The calibration of the above mentioned assets models may also be based on adequate actuarial and statistical analysis of economic variables provided they produce market consistent results. For example: a) To inform the appropriate correlations between different asset returns. b) To determine probabilities of transitions between rating classes and default of corporate bonds. c) To determine property volatilities. As there is virtually no market in property derivatives, it is difficult to derive property implied volatility. Thus the volatility of a property index may often be used instead of property implied volatility.

Assumptions consistent with generally available data on insurance and reinsurance technical risks
TP.2.116. Generally available data refers to a combination of: - Internal data - External data sources such as industry or market data. TP.2.117. Internal data refers to all data which is available from internal sources.
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Internal data may be either: - Undertaking-specific data: - Portfolio-specific data: TP.2.118. All relevant available data whether external or internal data, should be taken into account in order to arrive at the assumption which best reflects the characteristics of the underlying insurance portfolio. In the case of using external data, only that which the undertaking can reasonably be expected to have access too should be considered. The extent to which internal data is taken into account should be based on: - The availability, quality and relevance of external data. - The amount and quality of internal data. TP.2.119. Where insurance and reinsurance undertakings use data from an external source, they should derive assumptions on underwriting risks that are based on that data according to the following requirements: (a) Undertakings are able to demonstrate that the sole use of data which are available from an internal source are not more suitable than external data; and (b) The origin of the data and assumptions or methodologies used to process them is known to the undertaking and the undertaking is able to demonstrate that these assumptions and methodologies appropriately reflect the characteristics of the portfolio.

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Policyholders’ behaviour
TP.2.120. Undertakings are required to identify policyholders’ behaviour. TP.2.121. Any assumptions made by insurance and reinsurance undertakings with respect to the likelihood that policyholders will exercise contractual options, including lapses and surrenders, should be realistic and based on current and credible information. The assumptions should take account, either explicitly or implicitly, of the impact that future changes in financial and non-financial conditions may have on the exercise of those options. TP.2.122. Assumptions about the likelihood that policy holders will exercise contractual options should be based on analysis of past policyholder behaviour. The analysis should take into account the following: (a) How beneficial the exercise of the options was or would have been to the policyholders under past circumstances (whether the option is out of or barely in the money or is in the money), (b) The influence of past economic conditions, (c) The impact of past management actions, (d) Where relevant, how past projections compared to the actual outcome, (e) Any other circumstances that are likely to influence a decision whether to exercise the option. TP.2.123. The likelihood that policyholders will exercise contractual options, including lapses and surrenders, should not be assumed to be independent of the elements mentioned in points (a) to (e) in the
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previous paragraph, unless proper evidence to support such an assumption can be observed or where the impact would not be material. TP.2.124. In general policyholders’ behaviour should not be assumed to be independent of financial markets, of undertaking’s treatment of customers or publicly available information unless proper evidence to support the assumption can be observed. TP.2.125. Policyholder options to surrender are often dependent on financial markets and undertaking-specific information, in particular the financial position of the undertaking. TP.2.126. Policyholders’ option to lapse and also in certain cases to surrender are mainly dependent on the change of policyholders’ status such as the ability to further pay the premium, employment, divorce, etc.

Management actions
TP.2.127. The methods and techniques for the estimation of future cashflows, and hence the assessment of the provisions for insurance liabilities, should take account of potential future actions by the management of the undertaking. TP.2.128. As examples, the following should be considered: - changes in asset allocation, as management of gains/losses for different asset classes in order to gain the target segregated fund return; management of cash balance and equity backing ratio with the aim of maintaining a defined target asset mix in the projection period; management of liquidity according to the asset mix and duration strategy; actions to maintain a stable allocation of the portfolio assets in term of duration and product type, actions for the dynamic rebalancing of the assets portfolio according to movements in liabilities and changes in market conditions;

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- changes in bonus rates or product changes, for example on policies with profit participation to mitigate market risks; - changes in expense charge, for example related to guarantee charge, or related to an increased charging on unit-linked or index-linked business; TP.2.129. The assumptions on future management actions used in the calculation of the technical provisions should be determined in an objective manner. TP.2.130. Assumed future management actions should be realistic and consistent with the insurance or reinsurance undertaking’s current business practice and business strategy unless there is sufficient current evidence that the undertaking will change its practices. TP.2.131. Assumed future management actions should be consistent with each other. TP.2.132. Insurance and reinsurance undertakings should not assume that future management actions would be taken that would be contrary to their obligations towards policyholders and beneficiaries or to legal provisions applicable to the insurance and reinsurance undertakings. The assumed future management actions should take account of any public indications by the insurance or reinsurance undertaking as to the actions that it would expect to take, or not take in the circumstances being considered. TP.2.133. Assumptions about future management actions should take account of the time needed to implement the management actions and any expenses caused by them. TP.2.134. Insurance and reinsurance undertakings should be able to verify that assumptions about future management actions are realistic through a comparison of assumed future management actions with management actions actually taken previously by the insurance or reinsurance undertaking.
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International Association of Insurance Supervisors

IAIS Releases Proposed Policy Measures for Global Systemically Important Insurers

Public consultation to continue through 16 December 2012 Basel – The International Association of Insurance Supervisors (IAIS) today released its proposed policy measures for global systemically important insurers, or G-SIIs. The paper was endorsed for consultation by the Financial Stability Board (FSB), which is coordinating the overall project to reduce the moral hazard posed by global systemically important financial institutions. Supervisors, insurers and other interested parties are encouraged to submit comments on the proposed policy measures through 16 December. “These proposed policy measures are intended to reduce moral hazard and the negative externalities stemming from the potential disorderly failure posed by a G-SII,” said Peter Braumüller, Chair of the IAIS Executive Committee. “Each of the proposed policy measures has also been designed to take account of the specific nature of the insurance business model and is the result of intensive and thorough discussion at the IAIS.” The IAIS has proposed a framework of policy measures for G-SIIs based upon the general framework published by the FSB with adjustments that, as with the proposed assessment methodology, reflect the factors that make insurers different from other financial institutions. The proposal consists of three main types of measures:

1. Enhanced Supervision.
These measures build on the IAIS Insurance Core Principles and the FSB’s Supervisory Intensity and Effectiveness recommendations and
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include the development of a Systemic Risk Reduction Plan and enhanced liquidity planning and management.

2. Effective Resolution.
Based on the FSB’s Key Attributes of Effective Resolution Regimes for Financial Institutions, which include the establishment of Crisis Management Groups, the elaboration of recovery and resolution plans, the conduct of resolvability assessments, and the adoption of institutionspecific cross-border cooperation agreements. The IAIS proposals take account of the specificities of insurance through the inclusion of plans for separating non-traditional, non-insurance (NTNI) activities from traditional insurance activities, the potential use of portfolio transfers and run-off arrangements, and the recognition of existing policyholder protection and guarantee schemes.

3. Higher Loss Absorption (HLA) Capacity.
This proposal utilises a cascading approach. In the first step if, and to the extent to which, the G-SII has demonstrated effective separation of NTNI activities from traditional insurance activities, targeted HLA will be applied to the separate entities. Under the second step, whether or not NTNI activities have been separated, an overall assessment of group-wide HLA needed will be undertaken and the group wide supervisor will determine whether the HLA capacity held at the NTNI entities is sufficient or needs to be further increased.

About the IAIS:
The IAIS is a global standard setting body whose objectives are to promote effective and globally consistent regulation and supervision of the insurance industry in order to develop and maintain fair, safe and
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stable insurance markets for the benefit and protection of policyholders; and to contribute to global financial stability. Its membership includes insurance regulators and supervisors from over 190 jurisdictions in some 140 countries. More than 120 organisations and individuals representing professional associations, insurance and reinsurance companies, international financial institutions, consultants and other professionals are Observers.

Global Systemically Important Insurers: Proposed Policy Measures Public Consultation Document Comments due by 16 December 2012 Cover note
The global financial crisis underscored the interconnected nature of financial firms and the severe financial and economic costs associated with public sector interventions for those that were distressed or expected to fail. It also underscored the need to act promptly and proactively to identify firms that are systemically important and to take measures to lessen the impact and reduce the moral hazard associated with the failure of such firms. As such, the International Association of Insurance Supervisors (IAIS) is participating in a global initiative, along with other standard setters, central banks and financial sector supervisors, and under the purview of the Financial Stability Board (FSB) and G20, to identify global systemically important financial institutions (G-SIFIs). The focus of IAIS analysis is in relation to potential global systemically important insurers (G-SIIs).
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Earlier this year, the IAIS developed an assessment methodology to identify any insurers whose distress or disorderly failure, because of their size, complexity and interconnectedness, would cause significant disruption to the global financial system and economic activity. The IAIS has now developed a framework of policy measures that should be applied to insurers that are determined to be G-SIIs. Interested parties may wish to consult relevant background papers which are available on the IAIS, FSB and Basel Committee on Banking Supervision (Basel Committee) websites, including the IAIS’ report Insurance and Financial Stability. Other key papers include: • The IMF/FSB/Bank for International Settlements (BIS) staff report submitted to the G20 Finance Ministers and Central Bank Governors entitled Guidance to Assess the Systemic Importance of Financial Institutions, Markets and Instruments (October 2009); • The FSB’s recommendations on Reducing the moral hazard posed by systemically important financial institutions (SIFIs) (October 2010); • The Basel Committee framework for identifying global systemically important banks (G-SIBs) and requirements for additional loss absorbency for G-SIBs (November 2011); and • The determination of the first cohort of G-SIBs (November 2011). All comments will be published on the IAIS website, unless a specific request is made for comments to remain confidential.

Glossary of abbreviations
BCBS Basel Committee on Banking Supervision (also Basel Committee)
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BIS Bank for International Settlements CDS Credit Default Swap ComFrame IAIS Common Framework for the Supervision of Internationally Active Insurance Groups CMGs Crisis Management Groups FSB Financial Stability Board G-SIBs Global Systemically Important Banks G-SIFIs Global Systemically Important Financial Institutions G-SIIs Global Systemically Important Insurers G20 Group of Twenty Countries HLA Higher Loss Absorbency or Higher Loss Absorption capacity IAIGs Internationally Active Insurance Groups IAIS International Association of Insurance Supervisors ICPs IAIS Insurance Core Principles IGT Intra-group Transactions ISDA International Swaps and Derivatives Association Key Attributes FSB’s Key Attributes for Effective Resolution Regimes MCR Minimum Capital Requirement NTNI Non-traditional Insurance and Non-insurance activities
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PCR Prescribed Capital Requirement RRPs Recovery and Resolution Plans SIFIs Systemically Important Financial Institutions SRRP Systemic Risk Reduction Plan

Executive Summary FSB framework for G-SIFIs
The Financial Stability Board (FSB) framework for reducing the moral hazard and risk to the global financial system posed by systemically important financial institutions (SIFIs) recommends several policies which should combine to: • Apply more intensive and co-ordinated supervision of SIFIs, • Improve the authorities’ ability to resolve SIFIs in an orderly manner without destabilising the financial system and exposing the taxpayer to the risk of loss, • Require higher loss absorption (HLA) capacity for SIFIs to reflect the greater risks that these institutions pose to the global financial system, • Provide other supplementary prudential and other requirements as determined by the national authorities.

Policy measures proposed by IAIS
The IAIS proposes a framework of policy measures for G-SIIs in line with the FSB recommendations. Measures will often require strong cooperation among authorities, including authorities with responsibility for non-insurance entities.
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i) Enhanced supervision
The foundation for G-SII policy measures is the existing IAIS Insurance Core Principles (ICPs). The FSB’s “Supervisory Intensity and Effectiveness” recommendations (SIE recommendations) would form the basis of the IAIS’ approach to enhanced supervision. In addition, the IAIS Common Framework for the Supervision of Internationally Active Insurance Groups (ComFrame) will aim to foster global convergence of regulatory and supervisory measures and approaches for Internationally Active Insurance Groups (IAIGs), whether or not they are identified as G-SIIs, although ComFrame is not expected to directly focus on addressing systemic risk. For G-SIIs, the supervisor should have direct powers over holding companies to ensure that a direct approach to consolidated group-wide supervision can be applied. Special attention should be paid to group-wide supervision since G-SIIs are most likely to take the form of a group and NTNI (non-traditional and non-insurance) activities are often carried out by separate entities within a group and/or the group may have significant interconnections to other parts of the financial system. The supervisor should require G-SIIs to have, in particular, adequate arrangements in place to deal with liquidity risk management for the whole group, primarily for the NTNI business, but secondarily also for the remainder of the G-SII. The authorities should analyse activities that cause systemic importance of G-SIIs and take necessary measures to reduce that systemic importance.

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The authorities should oversee the development of a Systemic Risk Reduction Plan (SRRP) by each G-SII (in addition to recovery and resolution plans (RRPs)) to reduce that systemic importance and monitor implementation of the plan. Where feasible and appropriate, the SRRP may include effective separation of systemically important NTNI activities from traditional insurance business and/or restrictions or prohibitions of specified systemically important activities or any other measures. Where separation of NTNI activities is contemplated, the SRRP should seek to ensure it achieves self-sufficiency in terms of structure and financial condition of the separated entities. Structural aspects of self-sufficiency will likely involve a combination of restructuring measures and the restriction or prohibition of parental guarantees and cross-default clauses to ensure that any separation into legal entities is not undermined by contractual obligations. Self-sufficiency in terms of financial condition means there should be no capital or funding subsidies or multiple-gearing. The authorities should avoid the creation by the G-SII of non-regulated entities through the separation of NTNI activities. Any entities used to separate NTNI activities should be effectively regulated under direct consolidated group-wide supervision including coordination with other involved supervisors, as discussed above.

ii) Effective resolution
In 2011, the FSB published an international standard for resolution – “Key Attributes of Effective Resolution Regimes for Financial Institutions” (Key Attributes).

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This standard sets out a range of specific requirements that should apply to any financial institution that could be systemically significant or critical if it fail. The requirements applied to at least G-SIFIs include (i) The establishment of Crisis Management Groups (CMGs); (ii) The elaboration of recovery and resolution plans (RRPs); (iii) The conduct of resolvability assessments (iv) The adoption of institution-specific cross-border cooperation agreements For G-SIIs, effective resolution will take account of the specificities of insurance including: • Plans and steps needed for separating NTNI activities from traditional insurance activities, • The possible use of portfolio transfers and run off arrangements as part of the resolution of entities conducting traditional insurance activities, and • The existence of policyholder protection and guarantee schemes (or similar arrangements) in many jurisdictions.

iii) Higher loss absorption (HLA) capacity
Mandating a higher loss absorption capacity for a G-SII will help to reduce its probability of failure. This is important given the greater risks that the failure of G-SIIs poses to the global financial system.
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The IAIS proposes that the following cascading approach to achieve HLA capacity should apply. This is in line with the principle for HLA is to be targeted, where possible, at activities that have the potential to generate or aggravate systemic risk. • Step 1 – if, and to the extent to which, the G-SII has demonstrated effective separation of NTNI activities from traditional insurance activities, targeted HLA will be applied to the separate entities conducting NTNI activities. • Step 2 – whether or not NTNI activities have been separated, an overall assessment of group-wide HLA needed is required. In the case where Step 1 has been applied, this should take into account the HLA in the separate entities and the fact that separation exists, but only where that HLA was not created by multiple-gearing through down streaming capital within the G-SII. The group-wide supervisor determines (in consultation with involved supervisors) whether the HLA capacity held at the NTNI entities is sufficient or needs to be further increased at the group level. As an alternative to Step 2, there is on-going discussion within the IAIS on whether there is a need for group-wide HLA if targeted HLA, and other measures (such as restrictions and prohibitions), are effective in reducing the level of systemic importance to an acceptable level. Instruments comprising the highest quality capital – that is permanent capital that is fully available to cover losses of the insurer at all times on a going-concern basis – are the appropriate instruments to meet HLA capacity requirements. The HLA assessment will take into account any capital charges imposed to mitigate the systemic risk of an insurer that are in place under national legislation.
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Regarding the proposed policy measures on HLA, the IAIS will elaborate and develop a concrete plan by the end of 2013.

Implementation time frame
It is planned that the first cohort of G-SIIs will be designated and subsequently published in the first half of 2013. G-SII measures on enhanced supervision (including development of the SRRP) and effective resolution should begin to be implemented immediately afterwards. The SRRP and measures on effective resolution should be completed within 18 months after designation. The implementation of the SRRP should be assessed by the authorities in 2016. Measures on HLA capacity should begin to be implemented in 2019 for the G-SIIs designated in 2017 allowing for the assessment of implementation of structural measures in the SRRP. The IAIS expects national authorities to prepare a framework in which insurers will be able to provide high quality data for the indicators. To ensure the transparency of the methodology (for the benefit of market participants and to promote market discipline) and the efficient identification of G-SIIs, the IAIS expects all participating insurers to disclose relevant data when the G-SII policy is implemented and the IAIS will provide reporting guidance. Implementation of G-SII policy measures should be monitored by an IAIS peer review process in order to ensure international consistency. The full implementation timeframe is:
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1 Introduction
1. The IAIS is participating in a global initiative, along with other standard setters, central banks and financial sector supervisors, and under the purview of the Financial Stability Board (FSB) and G20, to identify global systemically important financial institutions (G-SIFIs). The focus of IAIS analysis is in relation to potential Global Systemically Important Insurers (G-SIIs). To this end, the IAIS has developed a public consultation document “Global Systemically Important Insurers (G-SIIs): Proposed Assessment Methodology”, explaining the proposed assessment methodology to identify any insurers whose distress or disorderly failure, would cause significant disruption to the global financial system and economic activity. Any such insurers should be regarded as systemically important on a global basis. 2. The IAIS has now also developed a proposed framework of policy measures for G-SIIs. The proposed framework is based upon the general framework published by the FSB with adjustments. As with the assessment methodology, these adjustments reflect the factors that make insurers, and the reasons why they might be systemically important, different to other financial institutions. 3. At the Summit meeting in Seoul, November 2010, the G20 leaders endorsed the FSB’s framework for reducing the moral hazard posed by systemically important financial institutions. The framework recommends several policies which should combine to:
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• Improve the authorities’ ability to resolve SIFIs in an orderly manner without destabilising the financial system and exposing the taxpayer to the risk of loss, • Require higher loss absorbency for SIFIs to reflect the greater risks that these institutions pose to the global financial system, • Apply more intensive and co-ordinated supervision of SIFIs, • Strengthen core financial infrastructures, and • Provide other supplementary prudential and other requirements as determined by the national authorities. 4. As discussed in the IAIS’ report, Insurance and Financial Stability, the two most important factors for assessing the systemic importance of insurers are non-traditional insurance and non-insurance activities and interconnectedness. Non-traditional and non-insurance (NTNI) activities are important because, among other matters, the longer timeframe over which insurance liabilities can normally be managed may not be present, and interconnectedness is important because there can be strong connections between the insurance and banking sectors that can amplify the impact of stress events. Therefore, the policy measures need to address these causes of systemic importance. 5. The purpose of this consultation document is to seek views from supervisors, industry and the public on the proposed policy measures framework for G-SIIs.

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2 Overview 2.1 The supervisory challenges in relation to G-SIIs
6. G-SIIs are a risk to financial stability because their scope, the nature of their business and their position in the financial system is such that, if they fail, they may cause disruption to the rest of the financial system and the real economy. 7. G-SIIs are different to Global Systemically Important Banks (G-SIBs), in part because the traditional insurance business model is not inherently systemically important. Insurers vary widely from banks in their structures and activities and consequently in the nature and degree of risks they pose to the global financial system. The activities or variations on the traditional insurance business model that would make an insurer a G-SII can vary greatly from one insurer to another. This requires a policy response designed to address the specific nature and source of systemic importance and the different drivers of possible negative externalities.

2.2 Objectives of G-SII policy measures
8. The proposed G-SII policy measures should reduce moral hazard and the negative externalities stemming from the potential disorderly failure posed by a G-SII. These policy measures should: • Reduce the probability and impact of distress or failure of G-SIIs and thus reduce the expected systemic impacts which disorderly failure may cause.
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• Incentivise G-SIIs to become less systemically important, and give non-G-SIIs strong disincentives from becoming G-SIIs, and • Be linked to the drivers of the G-SII status of each individual insurer. 9. G-SIIs may be regarded as a safe haven by policyholders and institutional investors, either because of a perceived implicit state guarantee or maybe more so because the policy measures are understood to bring an additional level of security. Within the financial market place, this might have substantial distortional consequences. For example, the G-SII designation of insurers could result in giving GSIIs access to lower funding costs. The financial strength rating assessment by credit rating agencies and the bespoke ratings assigned by investment banks and repo dealers today do not assume any implicit state guarantee for insurers. During implementation of the policy measures for G-SIIs, potential unintended consequences should be considered and avoided where possible.

3 The G-SII policy measures 3.1 Overview
10. The IAIS proposes a framework of policy measures for G-SIIs in line with the FSB recommendations.

• Enhanced supervision:
Enhanced supervision applies immediately to all G-SIIs to ensure that they rapidly achieve the higher standards of risk management their G-SII status demands.
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The Insurance Core Principles (ICPs), the common framework for supervision of internationally active insurance groups (ComFrame), and the FSB’s “Supervisory Intensity and Effectiveness” (SIE) recommendations would form the basis of the IAIS’s approach to enhanced supervision while special emphasis would be placed on groupwide supervision and liquidity planning, as described below. The authorities should also analyse activities that cause systemic importance of G-SIIs and take necessary measures to reduce that systemic importance. This includes development and implementation of a Systemic Risk Reduction Plan (SRRP) which could include measures such as separation of NTNI activities from traditional insurance business and/or restriction or prohibition of systemically important NTNI activities).

• Increased resolvability:
The FSB’s “Key Attributes for Effective Resolution Regimes” (Key Attributes) would be the basis for improved resolvability and would help reduce the impact of a G-SII failing. Under the Key Attributes, all G-SIIs will be required to produce recovery and resolution plans (RRPs) with their supervisor. The G-SII authorities will also be required to establish a crisis management group (CMG), conduct resolvability assessments and have cooperation agreements with other involved supervisors.

• Higher loss absorption (HLA) capacity:
This will entail the supervisor requiring the G-SII to hold more regulatory capital or to increase loss absorption capacity by other means. Higher capital will be targeted at those NTNI activities the G-SII undertakes which generate systemic risk if, and to the extent to which,
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the G-SII has demonstrated effective separation of NTNI activities from traditional insurance activities. It is noted that some national supervisory frameworks are expected to provide for capital surcharges that account for the systemic risk profile of an insurance group and these additional capital requirements would be taken into consideration in assessing whether the G-SII has an appropriate level of HLA capacity. 11. When applying policy measures authorities should keep the following points in mind: • Measures should be proportionate and should avoid unintended adverse consequences, where practicable • Measures should be directed at the source of systemic importance and linked to the assessment methodology • Measures will often require strong cooperation among authorities, including authorities with responsibility for non-insurance entities within the insurance group.

3.2 Enhanced supervision 3.2.1 General description
12. Enhanced supervision of G-SIIs will generally mean, in line with the SIE recommendations, specifically tailored regulation, greater supervisory resources and bolder use of existing supervisory tools compared to the supervision of non-systemically important insurers. The enhanced supervision of G-SIIs should include a direct approach to consolidated group-wide supervision and should especially focus on the unique risk profile and possible risk concentrations of G-SIIs in order to lessen the probability and impact of failure.
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In doing so, involved supervisors should take into account the reasons for the systemic importance of the G-SII suggested by the results of GSII assessment methodology. 13. The desired outcomes of enhanced supervision are: • The supervisor determines a set of measures to reduce the risks posed by the G-SII and establishes timelines and indicators to adequately monitor the effectiveness of the measures. • There is a group-wide supervisory framework that applies to the group as a whole with a particular focus on its systemic risks and the need for cooperation among supervisors, including supervisors with responsibility for non-insurance entities within the insurance group. Obstacles that could hinder effective group-wide supervision are identified and removed. For G-SIIs, the supervisor has direct powers over holding companies to ensure that a direct approach to consolidated group-wide supervision can be applied. • The supervisor has clear visibility of internal control systems and risk management and solvency assessment procedures within the insurance group. This includes requiring the G-SII to have the ability to aggregate and identify risk exposures and concentrations quickly and accurately at the group-wide level, across business lines and legal entities, and to other firms. • The G-SII has internal controls and limits that are appropriate, investments and reinsurance arrangements that are appropriately diversified, increased disclosure and additional stress testing. • Enhanced supervisory co-ordination is achieved via supervisory colleges (cross-sector and cross-jurisdictions).
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14. The IAIS approach to enhanced supervision builds on: • The IAIS ICPs, which are applicable to all insurers and will be the foundation for the G-SII policy measures. • The IAIS ComFrame, which will aim to foster global convergence of regulatory and supervisory measures and approaches for Internationally Active Insurance Groups (IAIGs), whether or not they are identified as G-SIIs, although ComFrame is not expected to directly focus on addressing systemic risk. • Special attention should be paid to group-wide supervision since GSIIs are most likely to take the form of a group and NTNI activities are often carried out by separate entities within a group. • The FSB’s recommendations for “Intensity and Effectiveness of SIFI Supervision”, (SIE recommendations), especially in relation to: – Unambiguous mandates, independence and appropriate resources Mandates geared toward active early intervention can facilitate a culture where supervisors have the will to act early. The mandate should convey the point that the supervisory authority’s risk view of a firm will always reflect a higher degree of conservatism and will therefore often be a source of conflict when viewed against the respective risk appetites of senior management, board and shareholders. Reinforcing the operational independence and resources of supervisory agencies is critical to ensuring supervisory effectiveness and credibility in general. Supervisor independence is of particular importance as the mandates of agencies is broadened to include authority to take countercyclical actions such as imposing more conservative underwriting standards in boom times, or raising capital requirements, which may run contrary to public perceptions of risk and be politically unpopular.
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– Full suite of supervisory powers Since the crisis, the need for tools such as increased liquidity requirements, large exposure limits, imposing dividend cuts, requiring additional capital etc. have come to the forefront. Given that a full suite of powers is critical to a supervisor executing their role, the inventory of required tools should be updated. Supervisors need to ensure that the stress testing undertaken is comprehensive and commensurate with the risks and complexities of these institutions. – Improved standards and methods Increased focus on outcomes of governance and business processes and greater use of horizontal reviews are desirable. Supervisors need to evaluate whether their approach to and methods of supervision remain effective or have, for example, moved too far toward focusing on adequacy of capital and control systems, and away from detailed assessments of sources of profits and financial data. Supervisory interactions with Boards and senior management should be stepped up, in terms of frequency, level of seniority, and assessment of their effectiveness. Consideration should be given to developing expanded guidance to supervisors on how to assess a board with the goal of being better armed with tools and techniques which enable better determination of board effectiveness. Supervisors should adopt proactive approaches to deal with succession planning and performance expectations for key positions within G-SIIs (e.g. CEOs, CROs, Internal Auditors), elements that should no longer be regarded as only internal matters for institutions. – Stricter assessment regime
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Supervisors should consider how their supervisory frameworks set internal control expectations (including risk management frameworks) for G-SIIs, and they should be confident that the assessment criteria for the control environment at G-SIIs set a “higher bar” for these firms to achieve in the areas of internal controls given the potential systemic impact that they pose. Supervisors should further explore ways to formally assess risk culture, particularly at G-SIIs. Establishing a strong risk culture at financial institutions is an essential element of good governance. – Group-wide and consolidated supervision Group-wide supervisory work can be impaired when supervisors do not have the legal right or ability to review the group entities including nonregulated entities (including parents and/or affiliates), yet those entities have the potential to pose risks to the regulated entity. Consolidated supervisory blind spots can be created when there are entities within the regulated firm that the consolidated supervisor does not have access to or influence over. In some cases this is caused by business lines that have a primary supervisor that is different from the primary supervisor of the consolidated entity. Competing mandates and approaches of these supervisors can fragment the overall supervisory effort. – Risk aggregation Supervisors should study their data needs and data processing capabilities in the context of the higher requirements for G-SII supervision. Where there are deficiencies in any or all of
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i) The type of data collected, ii) The authority’s ability to process the data in a timely and fulsome way, or iii) Their ability to collect ad-hoc data in a timely manner, these should be addressed as soon as possible. Supervisors need to consider putting in place additional data management and analysis processes for the information available from a range of sources, such as that collected by trade repositories and other centralised sources of financial data, so that key players in markets and market anomalies are identified.

3.2.2 Enhanced liquidity planning and management
15. The supervisor should require the G-SII to have adequate arrangements in place to manage liquidity risk for the whole group, primarily in relation to NTNI activities and key channels of interconnectedness and secondarily also for the remainder of the group. These arrangements should include written strategies and policies for liquidity risk management during normal and stressed conditions subject to clearly documented governance requirements. Adjustments for expected behavior of market participants and customers during stressed conditions (especially in relation to acceleration of liabilities) should be considered. Liquidity risk management policies should include all relevant issues. Relevant issues may include: the basis for managing liquidity (for example, regional or central); the degree of concentrations, potentially affecting liquidity risk, that are acceptable to the firm; a policy for managing the liability side of liquidity risk and potential effects of downgrades on rating triggers; the role of marketable, or otherwise
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realisable, assets; ways of managing both the firm's aggregate foreign currency liquidity needs and its needs in each individual currency; ways of managing market access; the use of derivatives to minimise liquidity risk (including potential for collateral calls and margin calls); and, if NTNI activities exist, the management of intra-day liquidity.

3.2.3 Structural measures and the Systemic Risk Reduction Plan (SRRP)
16. The authorities should analyse activities that cause systemic importance of G-SIIs and take necessary measures to reduce that systemic importance. The authorities should select the most effective policy measures to achieve this goal. The authorities should oversee the development of a SRRP by each GSII (in addition to the recovery and resolution plans (RRPs)) to reduce that systemic importance and monitor implementation of the plan. Where feasible and appropriate, the SRRP may include effective separation (so as to achieve self-sufficiency) of systemically important NTNI activities from traditional insurance business (in combination with targeted HLA) and/or restrictions or prohibitions of specified systemically important activities or any other measures.

3.2.3.1 Separation of non-traditional and non-insurance (NTNI) activities
17. Separation of NTNI activities is an ex-ante policy measure aiming for greater transparency, self-sufficiency and resolvability of G-SIIs by targeting the structure of G-SIIs. The desired outcomes of implementing this measure are:

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• Traditional insurance business is more strongly shielded from NTNI business and vice versa. The qualities and resilience of traditional insurance business can be largely preserved20, even in G-SIIs with less traditional operations. • The resolvability of G-SIIs is structurally improved ex-ante, unlike RRPs which are conceived ex-ante but executed ex-post. The resolvability of traditional insurance business can be largely preserved, even in G-SIIs with less traditional operations, and the resolvability of NTNI business is addressed. (see 3.3 Effective Resolution) • (In combination with targeted HLA) the expected impact of the distress or failure of the NTNI entities is reduced to non-systemic level. 18. The aforementioned outcomes are supported by the following combination of specific measures: • NTNI business is conducted in separate legal entities that are structurally and financially self-sufficient – Structural self-sufficiency means that it should be possible to ringfence (and liquidate) self-sufficient legal entities without impacting the remaining legal entities of a group. As well as legal entity separation, it requires that problematic NTNI intra-group transactions such as guarantees (especially any unlimited guarantees, upward and peer guarantees and intra-group transactions aimed at capital gearing) as well as cross-default clauses are prohibited or at a minimum adequately monitored and restricted. – Financial self-sufficiency requires economically adequate capitalisation of legal entities that account for their systemic importance and hence of the G-SII; avoiding certain structures designed to allow for undercapitalisation and subsidies of selected legal entities.
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• Subsidies in the form of capital and/or funding to the benefit of NTNI entities should not be allowed • Self-sufficiency in terms of structure and financial condition is to be monitored and verified by the authorities during the process of implementation of the SRRP. 19. Company structures exist in such a variety of forms that it is impossible to capture the structural measures in a set of allencompassing rules. The structure of G-SIIs becomes more transparent and hence tractable with their businesses separated according to the business segments proposed in Insurance and Financial Stability. This allows supervisors to target their supervisory actions and measures more effectively and efficiently to the nature and risks of the respective business segments. In terms of tractability and transparency, the organisational structure of G-SIIs would be simpler to understand if different types of activities and businesses were compartmentalised. The financial statements would also be simpler to understand if segment reporting is aligned accordingly. 20. The authorities should avoid the creation by the G-SII of nonregulated entities through the separation of NTNI activities. Any entities used to separate NTNI activities should be effectively regulated under direct consolidated group-wide supervision including coordination with other involved supervisors, as discussed above.

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3.2.3.2 Restrictions and prohibitions
21. The supervisor could choose to apply restrictions and prohibitions with the following goals in mind: - to reduce the probability and impact of failure resulting from systemically important activities within G-SIIs - to eliminate or limit systemically important activities based on the nature of the activity - to discourage such activities and thereby encourage G-SIIs to reduce or eliminate their systemically important activities and discourage other insurers from undertaking potentially systemically important activities. 22. Restrictions and prohibitions are most effectively applied to NTNI and interconnectedness activities and could be applied on a stand-alone basis or in combination with other policy measures. Restrictions and prohibitions could be targeted to specific legal entities within the G-SII or they could be tailored to specific systemic NTNI activities or those activities that make a company more interconnected. 23. Restrictions and prohibitions cover a broad range of options that include both direct prohibitions, limitations and restrictions on activities as well as measures that provide strong disincentives and/or internalise the costs for engaging in systemically important activities. These include: • Direct prohibition or limitation of the systemically important activity • Requirements for prior approval of transactions that fund or support systemically important activities
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• Requirements for spreading or dispersing risks relating to systemically important activities. • Limiting or restricting diversification benefits between traditional insurance business and other businesses. This measure improves the overall capital position and hence provides HLA capacity. In practical terms, it could either be applied at ultimate parent level or at the NTNI sub-holding or entity level 24. Given the premise that insurers are not likely to inherently generate systemic risk other than through NTNI and interconnectedness, prohibitions or strict limitations of an activity can be applied to G-SIIs where the goal is to eliminate the activity or severely curtail the risky activity. When a systemically important activity is conducted by a non-insurance entity within a group and joint banking and insurance make it more desirable to contain the risk rather than remove the activity, restriction may play a lesser role when compared with structural measures (e.g. segregation or separation) and HLA capacity.

3.3 Effective Resolution
25. The desired outcomes of effective resolution are: - to ensure the resolution of G-SIIs can take place without severe systemic disruption and without exposing taxpayers to loss, - to protect vital economic functions through mechanisms which make it possible for shareholders and unsecured creditors to absorb losses in a manner that respects the hierarchy of claims in liquidation,

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- to ensure that policyholder protection arrangements remain as effective as possible, - to avoid unnecessary destruction of value and ensure that non-viable G-SIIs can exit the market in an orderly way, and - to identify and remove impediments to smooth resolution.

3.3.1 Resolution regimes and tools for G-SIIs
26. In 2011, the FSB published an international standard for resolution – “Key Attributes of Effective Resolution Regimes for Financial Institutions” (Key Attributes). This standard sets out a range of specific requirements for institutions that should apply at a minimum to all G-SIFIs including G-SIIs. They include (i) The establishment of Crisis Management Groups (CMGs); (ii) The elaboration of recovery and resolution plans (RRPs); (iii) The conduct of resolvability assessments; and (iv) The adoption of institution-specific cross-border cooperation agreements. 27. To carry out an effective resolution, authorities need to have at their disposal a broad range of tools that enable them to intervene safely and quickly to protect policyholders and avoid destabilisation of financial markets. At present, many IAIS jurisdictions have a fourfold power in connection with the trigger points of a recovery system to require a solvency plan if the “prescribed capital requirement” (PCR) is breached, a financing
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plan if the “minimum capital requirement” (MCR) is breached, a recovery plan if the asset/liability ratio is breached and a liquidation plan if both the asset/liability ratio and the MCR are breached. These powers should be considered for RRPs of G-SIIs when they are in good health. The FSB Key Attributes should serve as a point of reference for the reform of national resolution regimes, setting out the responsibilities, instruments and powers that all national resolution regimes should have to enable authorities to resolve failing G-SIIs in an orderly manner and without exposing the taxpayer to the risk of loss. 28. It needs to be further examined whether a mainly traditional insurance group with a large derivatives portfolio may experience a disorderly run-off and, if so, whether there needs to be adjustments to the methodology or policy measures as a result. 29. Authorities will consider and take all necessary actions to ensure effective resolution including removing obstacles to the separability of non-traditional and non-insurance (NTNI) activities from traditional insurance activities during a stressed event. The resolvability assessment will include assessing whether, and the extent to which, effective ex ante separation of activities is in place. (See 3.2.3 Structural measures and the SRRP). 30. The FSB Key Attributes provide guidance to assist authorities in implementing the requirements for G-SIFIs. The IAIS concurs that these requirements are also relevant for G-SIIs, although insurance specificities need to be taken into account in implementing them. The FSB is currently developing an assessment methodology which should be used for assessments by the IMF and World Bank of national resolution regimes for financial institutions.
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The IAIS considers that the methodology should contain insurancespecific elements and hence is working closely with the FSB to ensure that the methodology addresses insurance specificities. Where necessary, the IAIS will explore with its members the need to develop further guidance for inclusion in the assessment methodology. Insurance specificities which need to be taken into account, include: • Plans and steps for separating NTNI activities from traditional insurance activities, • The possible use of portfolio transfers and run off arrangements as part of the resolution of entities conducting traditional insurance activities, and • The existence of policyholder protection and guarantee schemes (or similar arrangements) in many jurisdictions. 31. The IAIS will also consider whether to develop a template for assessing resolvability of G-SIIs. This template could assist authorities in identifying structural measures that would better prepare G-SIIs for resolution if the G-SII needs to be resolved. The issues discussed under the previous section 3.2.3.1 on separation should also be considered in this context.

3.4 Higher Loss Absorption (HLA) capacity 3.4.1 General description and purpose
32. All G-SIIs should have higher loss absorption (HLA) capacity to reflect the greater risks that G-SIFIs pose to the global financial system. The desired outcomes of HLA capacity, all of which work to reduce the probability or failure of distress and thus expected impact, include:
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• The G-SII is more resilient to low probability but high impact events. • Supervisors intervene earlier than they would for non-G-SIIs giving them more time to address emerging risks to the soundness of the G-SII. • Any implicit or explicit funding subsidy linked to G-SII status is offset. 33. HLA can be applied as an instrument at the group level or as a targeted instrument at the legal entity level if, and to the extent to which, the G-SII has demonstrated effective separation of NTNI activities from traditional insurance activities. 34. The application of HLA to G-SIIs is complicated by the fact that there is no global solvency standard for insurers. By requiring group-wide HLA, it might further aggravate differences between jurisdictions which might result in further regulatory arbitrage possibilities. Furthermore, the international differences in accounting and regulatory requirements would need to be considered when deciding the basis for any calculations, with IFRS, US GAAP or Japan GAAP with bridges to IFRS as the basis. 35. Mandating a higher loss absorption capacity for a G-SII will help to reduce its probability of failure. This is important given the greater risks that the failure of G-SIIs poses to the global financial system. The IAIS proposes that the following cascading approach to achieve HLA capacity should apply. This is in line with the principle for HLA is to be targeted, where possible, at activities that have the potential to generate or aggravate systemic risk. • Step 1 – if, and to the extent to which, the G-SII has demonstrated effective separation (so as to achieve self-sufficiency) of NTNI activities
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from traditional insurance activities, targeted HLA will be applied to the separate entities conducting NTNI activities. • Step 2 – whether or not NTNI activities have been separated, an overall assessment of the HLA needed at the group level is required. In the case where Step 1 has been applied, this should take into account the HLA in the separate entities and the fact that separation exists, but only where that HLA was not created by multiple-gearing through down streaming capital within the G-SII. The group-wide supervisor determines (in consultation with involved supervisors) whether the HLA capacity held at the NTNI entities is sufficient or needs to be further increased at the group level. • As an alternative to Step 2, there is on-going discussion within the IAIS on whether there is a need for group-wide HLA if targeted HLA, and other measures (such as restrictions and prohibitions), are effective in reducing the level of systemic importance to an acceptable level. 36. The HLA assessment will take into account any capital charges imposed to mitigate the systemic risk of an insurer that are in place under national legislation. 37. The structural measures required to achieve self-sufficiency are discussed in the previous section 3.2.3.1 on separation.

3.4.2 Methodology for applying group HLA capacity
38. There is currently no global solvency standard for insurance groups upon which to build HLA capacity requirements to apply consistently across jurisdictions. Nevertheless, the IAIS has decided in November 2011 that the capital component of the solvency assessment in ComFrame should have, among other items, a partly harmonised set of standards and parameters
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that sets out a narrow range of target criteria and time horizons for measurement purposes. 39. Currently, ICPs 17.3, 17.4 and 17.5 describe the concept of solvency control levels which could be used as the basis for applying HLA capacity. These ICPs specify a “prescribed capital requirement” (PCR), above which level the supervisor does not intervene on capital adequacy grounds. The PCR should be set such that, in adversity, an insurer’s obligations to policyholders will continue to be met as they fall due, that is, at a level such that the insurer is able to absorb the losses from adverse events that may occur over a defined period while technical provisions remain covered. HLA capacity would essentially be setting a higher PCR that accounts for the fact that the failure or distress of a G-SII is associated with negative externalities towards the global financial system and the economy, not just the policyholders and other direct stakeholders of the G-SII. 40. HLA capacity could be applied to the current national/regional solvency regime, as an HLA uplift to the closest conceptual equivalent to the PCR that is required under each country’s regulation. This approach should fit with most solvency regimes provided there is an equivalent of a PCR. Because it would be an add-on to the existing baseline solvency requirements in each jurisdiction, the large part of the overall solvency requirement should still be risk sensitive (to the extent that the existing regime is risk sensitive). This approach would also not impede the convergence of solvency standards over time.
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Step 1 – Targeted HLA capacity
41. If, and to the extent to which, the G-SII has demonstrated effective separation (so as to achieve self-sufficiency in terms of structure and financial condition) of NTNI activities from traditional insurance activities, targeted HLA will be applied to the separate entities conducting NTNI activities. Thus it sits where it is most needed in situations of stress. Targeted HLA capacity establishes an additional capital buffer and also makes it more expensive to carry out systemic activities. It is specifically aimed at the systemic NTNI business of insurers and is a disincentive as G-SIIs would require more capital. 42. Targeted HLA could directly affect the activities that pose systemic risk within the insurance business and also provides incentives to undertake any activities that pose systemic risk to a lesser extent. 43. For any banking or bank-like activities, whether carried out in a bank subsidiary or a non-insurance financial entity, the targeted HLA capacity could be set according to Basel III rules (eg HLA of at least 1% of riskweighted assets). Where Basel III can be used, it should be carefully designed to avoid regulatory arbitrage by applying the same rule to the same activity. Moreover, the same standards should apply to the same business in different jurisdictions to ensure a level playing field. 44. For other NTNI activities, the supervisor would need to determine suitable rules based on the nature of the activities and the principles in the ICPs and other relevant regulatory frameworks. The IAIS will provide guidance for supervisors as part of the proposed concrete policy measures on HLA, by the end of 2013.
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Step 2 – Group-wide HLA capacity
45. Under Step 2, an overall assessment of the HLA needed at the group level is required. In the case where Step 1 has been applied, this should take into account the HLA in the separate entities and the fact that separation exists, but only where that HLA was not created by multiple-gearing through down streaming capital within the G-SII. Possible add-ons should also be considered. Ideally, the level of groupwide HLA capacity should reduce the expected impact of a G-SII failing to an agreed benchmark. One way to set the appropriate level of group-wide HLA capacity would be so that the probability of failure is reduced to the point that the expected impact of a G-SII failing equals the expected impact of other similar insurance groups that are not G-SIIs failing. This approach is not considered feasible in the short term, as there is not sufficient data available to make a proper assessment.

Application of the HLA uplift
46. Deciding a basis to calculate the HLA uplift is complicated by different solvency regimes and accounting requirements across jurisdictions. Two options on which the HLA uplift could be based are to use a capital measure or a balance sheet measure:

i) Capital measure based on existing local solvency regimes

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The capital measure could be the nearest equivalent solvency standard to the PCR and the HLA uplift would be a percentage of the PCR (possibly in the range of 10% to 30%). Advantages: • Simple to handle. • Consistent with the concept of PCR which is the baseline of HLA uplift. Disadvantages: • As the baseline of group-wide HLA capacity is different, distortions could occur, depending on what business is being taken into account under local regimes and whether the major part of the business lies in jurisdictions with higher or lower regulatory capital requirements. • Aggregation of local regimes may not create a sufficient capital measure or, conversely, may provide an excessive capital measure. • Most local regimes will have little or no regard for specific treatment of NTNI activities.

ii) Total balance sheet (including off-balance sheet positions)
The balance sheet measure could be based on the total balance sheet (excluding capital but including off balance sheet items) and the HLA uplift would be a percentage of that amount (possibly in the range of 0.5% to 1.5%). It should be considered whether and how to deduct insurance assets and insurance liabilities in an appropriate manner in order to dis-incentivise reductions in insurance technical reserves and related assets. Advantages:
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• More global approach • Improves comparability between G-SIIs provided IFRS, US GAAP or Japan GAAP with bridges to IFRS are used as a basis • Independent from the levels of regulatory capital, and hence may provide more consistency between jurisdictions than the previous approach. Disadvantages: • Not as precise as a fully-fledged economic capital regime. • Not risk-sensitive, and could be inconsistent with an insurer's risk management framework. • Accounting differences across jurisdictions in the calculation of insurance liabilities mean this approach could also yield considerable inconsistency of HLA uplift. • This approach penalises insurers with healthier balance sheets within jurisdictions, including those insurers that maintain more conservative technical provisions. • It is technically difficult to define off-balance sheet items.

3.4.3 Acceptable instruments
47. Currently, there is no common global definition of capital in the insurance sector. The ICP 17.11.34 provides an example of broad categorisation of capital as follows.

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a. Highest quality capital: permanent capital that is fully available to cover losses of the insurer at all times on a going-concern and a wind-up basis; b. Medium quality capital: capital that lacks some of the characteristics of highest quality capital, but which provides a degree of loss absorption during on-going operations and is subordinated to the rights (and reasonable expectations) of policyholders; c. Lowest quality capital: capital that provides loss absorption in insolvency/ winding-up only. 48. The FSB report, endorsed at the G20 Seoul Summit in November 2010, states that G-SIFIs should have greater loss absorption capacity whereby a higher share of their balance sheets is funded by capital and/or by other instruments which increase the resilience of the institution as a going concern. 49. In line with the FSB recommendation, given the going-concern objective of the HLA capacity requirement, the HLA capacity should be met by the highest quality capital as defined in the above-mentioned ICP 17.11.34. Instruments comprising the highest quality capital – that is permanent capital that is fully available to cover losses of the insurer at all times on a going-concern basis – are the appropriate instruments to meet a HLA capacity requirement for the time being. 50. The supervisor should judge whether an instrument which exists in its jurisdiction constitutes the highest quality of capital or not. It should also be noted that the IAIS has decided that a common definition of capital resources is to be established by 2013. 51. Attention should be paid to the fact that the additional capital should sit in the place where it is most needed (e.g. in separate NTNI businesses).
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Otherwise, particularly if sitting in non-regulated entities (e.g. holding companies), issues relating to supervisory powers as well as transfer impediments might arise.

3.4.4 Refining the HLA capacity requirement
52. The IAIS will elaborate the above-mentioned HLA capacity measure and develop a concrete proposal by the end of 2013 taking into account that a sufficient transitional period of the introduction of this measure has been proposed as implementation is scheduled to begin from 2019 (see section 4).

4 Implementation 4.1 Implementation timeframe
53. The starting point for the implementation of G-SII policy measures is the public determination by the FSB and national supervisory authorities that a particular insurer is found to be a G-SII. For each G-SII, the group-wide supervisor would contact the G-SII to commence the process of implementing required policy measures. The key dates and timeframes are expected to be:

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54. Discussions with the G-SII would focus first on the particular drivers of G-SII status. The authority would immediately begin to implement measures with regards to enhanced supervision (including development of the SRRP) and effective resolution. The SRRP and resolution measures should be completed within 18 months after G-SII designation.
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The implementation of the SRRP should be assessed by the authorities 3 years after G-SII designation. Implementation of the SRRP is a prerequisite for application of the targeted HLA capacity requirements. 55. Regarding the proposed policy measures on HLA, the IAIS will elaborate and develop a concrete plan by the end of 2013. 56. The HLA capacity requirements will apply from 2019 for those G-SIIs designated in 2017 and will be based on the status of implementation of the SRRP in 2017. The list of designated G-SIIs will be updated every year. After the first designation in 2017, a newly designated G-SII will be allowed to have the same period to meet the HLA capacity requirement. 57. The IAIS expects national authorities to prepare a framework in which insurers will be able to provide high quality data for the indicators. To ensure the transparency of the methodology (for the benefit of market participants and to promote market discipline) and the efficient identification of G-SIIs, the IAIS expects all participating insurers to disclose relevant data when the G-SII policy is implemented and the IAIS will provide reporting guidance. 58. Implementation of G-SII policy measures should be monitored by an IAIS peer review process in order to ensure international consistency.

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EIOPA Work Programme 2013
EIOPA Work Programme 2013 describes the goals and deliverables for EIOPA in its third year of operation. EIOPA has decided to reshape the structure of its Work Programme, following the recommendation from the European Court of Auditors, aligning it with the tasks that the Regulation settling EIOPA assigns to the Authority. Such change in structure has not affected the highly ambitious programme presented for 2013, nor the high quality internal standards that inform and guide all EIOPA deliverables. The content of this Work Programme is driven by EIOPA role towards Supervisory and Regulatory Convergence, the core importance that Consumers have in EIOPA strategy and Mission, and the active role in the field of Financial Stability and Crisis Management. Relevant projects such as Solvency II will be reshaped, with a clear shift from regulation to supervision. Other areas of work, in particular in the field of pensions, will demand significant efforts from EIOPA in terms of sound and quality deliverables to the European Commission in the frame of their projected enhancement of pensions regulation. Supervisory tasks, and their convergence, rank high among EIOPA priorities. Concrete deliverables such as a supervisory handbook, an internal models support expert unit, or an enhancement of the role and scope of the colleges of supervisors will be provided during 2013.
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External relations, within Europe and outside, will continue playing a significant role in EIOPA deliverables. EIOPA places great value on the formal opinions, and other contributions, made by its two stakeholder groups for insurance and for occupational pensions. In addition to its sectoral work, EIOPA’s Chair will take the Chairmanship of the Joint Committee of ESAs. All these developments will entail a further growth of the organisation, in terms of budget and resources. Staff number, if the Budgetary Authority agrees to the request of EIOPA, will grow up to 112, to achieve the objectives and deliverables set in this Work Programme. Priorities still have to be made with regards to EIOPA mandate, as the Authority will only reach its anticipated size in 2020. For 2013, according to EIOPA proposal, the budget will grow from 15.6 to 20 million Euro, with a share of 40% from the Commission and 60% from its Members. If at the end of the budgetary process EIOPA’s budget would not reach the aforementioned figure, the Work Programme would be reprioritized and some of the deliverables today incorporated would have to be postponed. These deliverables are marked green in Annex I of the Work Programme. The language versions of the document’s main part will be made available at a later stage.

_________________________________________ Solvency ii Association www.solvency-ii-association.com

Insurance
The European insurance market is the largest in the world. Given its importance there will be substantial benefits from the introduction under Solvency II of a Europe-wide harmonised framework which provides the right incentives for insurers to better understand, measure and manage their risks. EIOPA has already achieved a great deal in the preparation for Solvency II. EIOPA is currently consulting on the technical standards and guidelines in order to complete the legislative framework for Solvency II. Its last quantitative impact study (QIS5) of the impact of Solvency II was the most ambitious and comprehensive impact study ever carried out in the financial sector, involving more than 2,500 insurance companies. It has provided technical contributions during the political discussions on key aspects of Solvency II such as long term guarantees and reporting. It is already carrying out assessments of whether third countries’ insurance frameworks are equivalent to those of the EU’s. In 2013 EIOPA will finalise the standards and guidelines which insurance undertakings require as part of the Solvency II framework. These will comprise the 53 standards and guidelines mandated by legislation and on its own initiative a guideline on external scrutiny or audit for the purposes of Solvency II publicly disclosed information. The standards and guidelines will cover the solvency capital requirements, own funds, internal models, group supervision, supervisory
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transparency and accountability, reporting and disclosure, valuation, the valuation of assets and liabilities other than technical provisions, and governance. In 2013 EIOPA will also continue to identify, scope and implement the operational tasks required of it under Solvency II. This includes the following - Publishing a list of authorised firms, - Collecting and publishing a report about the use of capital add-ons and the extent to which they are consistently applied across member states - Deriving and publishing the risk free rate. - Mapping the ratings of External Credit Assessment Institutions. - Publishing lists of typologies of regional governments and local authorities, exposures to whom are to be treated as exposures to the central government. - Specifying adjustments to be made for currencies pegged to the euro. - Choosing the equity index for the equity dampening mechanism - Determining, at the request of national supervisory authorities or on its own initiative, the existence of an exceptional fall in financial markets for the application of the extension of the SCR recovery period - Reporting to the European Parliament on the functioning of supervisory colleges and the appointment of the group supervisor. These specific operational tasks are accompanied by generic tasks which have been given to EIOPA as part of the new supervisory structure.
_________________________________________ Solvency ii Association www.solvency-ii-association.com

This includes the power for binding mediation, further work on equivalence assessments, and membership of colleges of supervisors. EIOPA will consider what should be the configuration of working groups and other mechanisms to deliver this next phase of insurance regulation. On its own initiative EIOPA will also deliver the following during 2013: - Start working on best practices with respect to aspects of the Supervisory Review Process for supervisors as a practical step to contributing to a common supervisory culture among supervisors - Develop a centre of expertise on the use of internal models under Solvency II - Collect data in EIOPA for further use for the purposes of financial stability and micro-prudential analysis, as part of implementing EIOPA’s database strategy EIOPA will continue in 2013 to build links between the Solvency II framework and other areas. It will complete the current assessments of equivalence of third countries and begin to assess the impact on consumer choice of the solvency II framework. EIOPA’s plans are naturally dependent on political and other developments, especially with respect to the quantitative supervisory framework. EIOPA will also enter a process of maintenance of its standards and guidelines; this maintenance includes: - The revision of standards and guidelines already published. - The potential drafting of additional guidelines and recommendations,
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following the further needs which might be identified through communication with stakeholders and National Supervisory Authorities.

Colleges
Colleges of Supervisors (Colleges) are considered efficient and effective tools used in supervision of financial institutions, and they are essential instruments to enhance mutual understanding among supervisors and convergence of supervisory practices, with tangible benefits to undertakings, supervisors and policyholders. The overall strategic target of EIOPA’s college work is to build the position of the EEA supervisory community towards the cross border operating insurance groups for the benefit of both group and solo supervision. The focus is on combining and leveraging the knowledge and forces of the National Supervisory Authorities in the EEA to form a strong and equal supervisory body to effectively deal with centrally organized and managed undertakings. According to EIOPA Regulation, day to day supervision as well as the set up and organisation of the Colleges is the responsibility of the National Supervisory Authorities. EIOPA as a member of Colleges promotes communication, cooperation, consistency, quality and efficiency in Colleges and provides oversight. EIOPA established in 2011 and reinforced in 2012 a highly qualified College Team and each staff member has a portfolio comprising several Colleges. This allows EIOPA to cover all 93 colleges currently active in Europe, targeting physical participation in at least 70 colleges of supervisors during 2013.
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EIOPA expects that the added value brought by EIOPA into the Colleges and activities of the Colleges will have improved considerably in 2012 and in 2013 the participation of EIOPA Staff in the Colleges can be consolidated. When monitoring the functioning of Colleges, the result will form the basis of EIOPA’s Action Plan for Colleges 2013 and include measurable, realistic, and at the same time ambitious goals. As for the 2012 Action Plan, the performance of individual colleges on the agreed deliverables will be made public. In 2013 EIOPA will: - Promote specifically the finalisation of the preparation of the Colleges for Solvency II, e.g. coordination agreements are expected to be agreed by year-end 2013 by all Colleges - EIOPA staff will continue as a Member in the Colleges to advise Group Supervisors and Colleges on the possibilities to improve the functioning of their College. Practical solutions and examples of supervisory practices will be collected - Develop best practices on specific topics with a particular focus on delegation of tasks amongst supervisors - To promote a common understanding of the group’s risk profile within Colleges, EIOPA will prepare for a data collection and analysis system for peer comparisons as a support function to Colleges

_________________________________________ Solvency ii Association www.solvency-ii-association.com

Hearing before the Committee on Economic and Monetary Affairs of the European Parliament
Dear Madam Chair, Dear Honourable Members, I am very pleased to appear before this Committee today to inform you about the activities of the European Systemic Risk Board (ESRB).

Introductory statement by , Chair of the ESRB, Brussels

As you know, the ESRB complements the know-how of central banks, national supervisors and the three European Supervisory Authorities by delivering what has come to be called a macro-prudential perspective. What this means is the capacity to analyse risks across market segments, to address vulnerabilities – which currently lie mainly in the banking sector – and to examine medium-term risks in the financial system as a whole. Based on such analysis, combined with proposals for remedial action by way of warnings or recommendations, the ESRB will help to protect Europe’s economy from fragility in the financial system. An important step in the ESRB’s work was the publication of the first risk dashboard on 20 September 2012.

_________________________________________ Solvency ii Association www.solvency-ii-association.com

The dashboard was requested by this Parliament in the legislative process establishing the ESRB. It consists of a set of quantitative and qualitative indicators aimed at identifying and measuring systemic risk. The risk dashboard has been produced in cooperation with the European Central Bank (ECB) and the three European Supervisory Authorities (ESAs). It is one of the inputs considered by the ESRB’s General Board in its discussions of risks and vulnerabilities in the financial system. The dashboard, which will be updated quarterly, looks at six different categories of risks, sectorally and across the financial landscape. It should be considered an information tool that orients further analysis on systemic risk, rather than a fully-fledged early warning system. The General Board has decided to publish the dashboard and its underlying data on the ESRB’s website.

Risks in the banking sector
Let me turn to the current situation. The European economy and financial system continue to face challenging times – and it is vital always to be mindful of systemic risks. But there are also reasons to be confident, provided that policy-makers continue to implement agreed measures with determination. These measures include macroeconomic and structural reforms to ensure competitiveness and sustainable public finances. They include continued financial reform to ensure a resilient and wellfunctioning financial system.
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And they include further development of Europe’s institutional framework. From a macro-prudential perspective, there are three main possible risks. First, the risk of setbacks in the implementation of agreed measures. Second, the risk of downside macroeconomic news with implications for banks’ asset quality, profitability and funding. And third, the risk that feedback loops between these two factors may affect the supply of credit, which in turn will affect the real economy. Revitalising the supply of credit is crucial for the recovery. Notwithstanding some reductions in market tensions, financial activity remains impaired in various parts of the system. At this time, the role of macro-prudential policy is primarily to restore trust in the financial sector. To rebuild investors’ confidence in banks, it is necessary to reassure them about asset quality. There are a number of options that authorities can consider. One is enhanced disclosure, for example, on the level of provisioning. A second option is supervisory assessments of asset quality, possibly including peer reviews by supervisors and third party assessments and a third option, where necessary, is the setting up of separate entities to deal with low quality assets. Important work is already being done by the European Banking Authority (EBA), assessing forbearance in the banking sector, promoting coordinated reviews of asset quality and harmonising definitions of key variables – such as non-performing loans.
_________________________________________ Solvency ii Association www.solvency-ii-association.com

The ESRB plans to make further proposals for macro-prudential policy, particularly on vulnerabilities linked to bank funding. In light of the impairment of some credit and interbank markets, the ESRB, together with the EBA, is reviewing asset encumbrance and complex funding instruments such as synthetic exchange-traded funds and liquidity swaps. The aim is to identify sources of systemic risk and policy actions to mitigate them. I intend to present the results of this process at the next hearing in the first half of 2013.

Risks in financial markets
The ESRB’s examination of the financial system extends well beyond the banking sector. Today, I would like to focus in particular on developments in the field of central counterparties (CCPs) and over-the-counter (OTC) markets. I will outline the analytical work done by the ESRB and the policy advice it has given. The implementation of the G20 commitment to central clearing for all standardised OTC derivatives has important consequences for the EU financial system. The ESRB started to assess the systemic implications of the more prominent role for CCPs that they will become a crucial node within the financial system. Macro-prudential examination of CCPs relates, in particular, to the procyclicality of margining and haircutting practices. Such practices have an important bearing on financial conditions in the economy. While the more prominent role for CCPs reduces counterparty risk, it inevitably implies an increase in concentration risk.
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Therefore, the ESRB issued advice to the European Securities and Markets Authority (ESMA) on two aspects regarding the systemic resilience of CCPs. On collateral, the ESRB advised the ESMA to increase the systemic resilience of CCPs by better defining the type of eligible collateral and the conditions under which commercial bank guarantees may be accepted as collateral by CCPs. The ESRB also advised that risks related to cross-collateralisation should be adequately taken into account. On clearing among non-financial corporations operating in derivative markets, the ESRB advised the ESMA to restrict the possibilities for such corporations to settle outside CCPs, so as to reduce counterparty risk. Regrettably from a macro-prudential viewpoint, there is a risk that the systemic vulnerabilities identified by the ESRB will remain at least partly unaddressed. This is due to an interpretation of the EMIR legislation that has made it difficult to translate fully the ESRB’s advice into technical standards. On OTC markets more broadly, the ESRB is examining potential risks stemming from market practices that have become very common in the so-called ‘shadow banking’ sector. For example, collateral pledged by a client may be re-used by a lender for own borrowing needs. This pattern, which is called re-hypothecation, may be repeated several times for the same collateral. It can therefore create a contagion chain in case any party fails to deliver. In other cases, when collateral for securities lending transactions is represented by cash, that cash may re-invested by the lender.
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In case such re-investment takes place in a risky asset or for a longer maturity, there are risks of so-called reuse of cash collateral in securities financing transactions.

Macro-prudential policies in the EU Banking union and the role of the ESRB
The ESRB has also reviewed the current plans on the banking union and welcomes the European Commission’s proposal. Board members consider that the macro-prudential benefits of the Single Supervisory Mechanism (SSM) would be enhanced if an adequate resolution regime for banks were implemented without substantial delay. The Commission’s initiatives for establishing a ‘single resolution mechanism to resolve banks and to coordinate the application of resolution tools to banks under the banking union’ are to be encouraged. The ESRB is reflecting on the implications of the proposed SSM for its own work. The Commission’s proposal directly affects macro-prudential policy and its implementation – suggesting for the ECB exclusive competence within the euro area ‘to set counter-cyclical buffer rates and any other measures aimed at addressing systemic or macro-prudential risks in the cases specifically set out in Union acts’. The ESRB has repeatedly stressed that macro-prudential policies should be sufficiently flexible to prevent the build-up of systemic risks. Policy-makers should be encouraged to mitigate emerging risks as soon as they are identified, rather than fostering a bias towards inaction. Flexibility can be balanced by members’ coordination to safeguard against potential negative externalities or unintended consequences.
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The ESRB is working on a general framework for the coordination of macro-prudential policies in the EU. First results can be expected in the coming year. Meanwhile, a review of the mission and organisation of the ESRB itself will take place in 2013. Three members of the ESRB Steering Committee – Stefan Ingves, Chair of the Advisory Technical Committee, André Sapir, Chair of the Advisory Scientific Committee, and Vítor Constâncio, Vice-President of the ECB – will examine the functioning of the ESRB, including in light of the forthcoming banking union.

Follow-up on ESRB recommendations
The ESRB is also working on first implementation of the ‘act or explain’ mechanism set out in the ESRB Regulation to ensure that addressees respond properly to ESRB recommendations. The first set of deadlines for replies to the ESRB recommendations issued in 2011 expired in June 2012. The current review suggests that the ‘act or explain’ mechanism has functioned smoothly. At the same time, more work lies ahead to enhance our assessment framework. The ESRB Secretariat has contacted relevant European and international institutions – such as the Commission, the IMF, the OECD, the FSB and the Bank for International Settlements – to learn from their experience.

Conclusions
In concluding, I would like to emphasise that there is substantial progress in the understanding of systemic risks and the design of macroprudential policies in the EU.
_________________________________________ Solvency ii Association www.solvency-ii-association.com

This would not have been possible without the active involvement and dedication of all ESRB member institutions and committees. On the occasion of the rotation of the Chair of the Advisory Scientific Committee, I would like to thank in particular its first Chair, Martin Hellwig, and to wish all the best to the new Chair, André Sapir. I understand that you will have the opportunity to exchange views with the Chair and Vice-Chairs of the Committee very soon. Thank you very much for your attention. I am now at your disposal for questions.

_________________________________________ Solvency ii Association www.solvency-ii-association.com

Solvency II – monitoring the ongoing appropriateness of internal models
Julian Adams, Director, Insurance In June 2012 I wrote to all firms in our internal model approval process to share our thinking on the way we will monitor the ongoing appropriateness of internal models after approval. This letter gives an update on the development of early warning indicators and reiterates the purpose and intended use of the indicators. Our underlying concern is that, if not adequately monitored and updated, the solvency standard delivered by internal models can deteriorate over time. The implementation of internal models inherently rests on a great number of judgements and assumptions, both explicit and implicit. Our experience suggests that, over time, if models are not appropriately updated, these assumptions and judgements can become less appropriate, leading to an overall reduction in solvency standards. We therefore continue to develop early warning indicators to ensure that the Solvency Capital Requirement (SCR) will meet the Solvency II calibration on an ongoing basis. To achieve this objective, we believe that early warning indicators: a. should be based on metrics that are independent from the internal model calculations, i.e. not based on the firm’s modelled SCR; b. should be simple in their construction, calibration and application, avoiding complexity; and
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c. will, if breached, trigger an immediate supervisory response; a capital add-on is, in all but exceptional cases, likely to be the most effective way to restore compliance with the Solvency II calibration requirement (i.e. 99.5% over a one-year period). We consider that the use of early warning indicators is consistent with the supervisory powers set out in the Solvency II Directive and as such will form part of the supervisory review process for internal model firms. The early warning indicators would supplement information collected from firms during the supervisory review process, including in particular the results of model validation as well as any approval of changes to the model. Further, the calibration of the indicators will aim to identify significant deviations in firm risk profile with respect to the assumptions underlying the calculation of the SCR.

Industry responses
We received ten responses to our June 2012 letter. Overall, they focussed on how we will monitor the ongoing appropriateness of an internal model at the individual firm level. These are useful suggestions which we will take into account as part of our supervisory review process. We also received some suggestions of an alternative indicator to the proposed ratio between the pre-corridor Minimum Capital Requirement (pMCR) and modelled SCR and we are investigating credible alternatives. We did not receive any comments on the proposed industry sub-sector segmentation set out in the letter.

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Some respondents noted that the construction should also allow for the capture of the underwriting cycle, and be mindful of the potential for pro-cyclicality and we will take this feedback into consideration in further work. A number of respondents expressed support for a European approach and we have shared our thinking with EIOPA. I would like to confirm that we do not intend to use a multiple of the pMCR indicator, or any other early warning indicator, as a condition to the approval of a firm’s use of an internal model. Our work with firms in the run up to implementation will inform the calibration for the indicators at day one. As I said in my letter in June, we expect that, in the vast majority of cases, firms submitting a model that properly reflects the firm’s risk profile to the standard required by the Solvency II Directive, and which is approved by us, will fall within the ratio or range of the indicator. So this should not be an issue for approved models on day one. Fundamentally, the purpose of the indicator is to limit subsequent downward SCR drift relative to risk profile. We have set out our intention to review the indicators periodically, both from our experience of their use and their calibration. In response to comments received that the early warning indicators would not allow for the reflection of the nature of and risks run by individual insurers - we will not be providing calibration for indicators at an individual firm level as this runs counter to the policy approach to have a simple, easy-to-apply indicator.

_________________________________________ Solvency ii Association www.solvency-ii-association.com

Next steps
There is still an opportunity for further engagement from the industry by cob Friday 26 October on early warning indicators that deliver the policy approach set out above. We also welcome suggestions for the segmentation set out in the June letter. You can send your response to your usual supervisory contact or to me directly. In the meantime we will be using data from firms to inform the development and calibration of early warning indicators. Yours sincerely

Julian Adams Director, Insurance

_________________________________________ Solvency ii Association www.solvency-ii-association.com

Solvency II: monitoring the ongoing appropriateness of internal models
As part of our commitment to share developments in our approach to the implementation of the Solvency II Directive, we wanted to set out our thinking on the way in which we would monitor the ongoing appropriateness of internal models after approval.

Model approval and beyond
As required by the Solvency II Directive, we will only approve an internal model for the calculation of the Solvency Capital Requirement (SCR) if we are satisfied that the systems for identifying, measuring, monitoring, managing and reporting risks are adequate and in particular if the model fulfils the tests and standards set out in the Solvency II framework. While our focus is on the work we need to do to be able to give firms a decision on their internal model application in time for the first day of the regime, we are also looking ahead to how we use our knowledge and learning to monitor the ongoing appropriateness of a firm’s internal model in the new regime. Following approval, firms are responsible for ensuring the ongoing appropriateness of the internal model, by ensuring that the internal model meets the tests and standards and reflects the firm’s risk profile. Firms should also ensure that the SCR is calibrated and corresponds to the value at risk of their basic own funds of the firm, subject to a confidence level of 99.5% over a one-year period. This means that we need to be assured that firms have put in place systems which ensure that the internal model operates properly on a continuous basis. We also need to be confident that the controls put in place are adequate and effective at all times, including stressed market conditions or crises.
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At a market level, we will monitor the movement of insurance sector capital over time. Our experience of internal models to date tells us that significant effort is put into an approval process, without adequate attention given to ongoing appropriateness. This leads to a risk that standards of solvency deteriorate over time. Based on the requirements of the Solvency II Directive, it is our expectation that models will be monitored and updated regularly to reflect the firm’s risk profile and to ensure compliance with model requirements.

Early warning indicators
To this end, we are developing a number of early warning indicators aimed at helping us and firms ensure that, after approval, internal models and the SCR calculation remain appropriate on an ongoing basis, at both firm and system level and that firms’ internal models continue to deliver outputs that are consistent with the requirements of Solvency II. We will use the information provided by firms in their Solvency II regulatory reporting to assess their position relative to these indicators (which may take the form of ratios or ranges) and so, the development of these indicators will not in itself create an additional reporting requirement. However, firms will be required to notify us immediately in the event their position falls outside these pre-determined ranges. In all but exceptional cases, we will take immediate supervisory action. This could include seeking a revision of the parameters and/or imposing a capital add-on.
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The aim of this action will be to increase the SCR so as to bring it once again above the indicator level with a view to ensuring that it complies with the Solvency II calibration requirement (i.e. 99.5% over a one-year period). In the meantime (and in any event), the firm and the FSA will work together to understand the issues better, which may result in improvements to the firm’s model. We propose to use a number of early warning indicators to assist us with our monitoring of capital on a firm-specific and industry-wide basis. The indicators will be tailored to specific sectors of the insurance market. We will periodically review the indicators, both from our experience of their use and their calibration.

Ratio between the pMCR and modelled SCR
One of the indicators that we are currently developing is a ratio between the pre-corridor minimum capital requirement (pMCR) and the modelled SCR. Separate pMCR indicators would be set at the level of an industry subsector to give us a high degree of assurance that the model is delivering a calibration at 99.5% over a one-year period. We intend to have indicators for firms which undertake: • life business, excluding with-profits business; • with-profits business; • general insurance business, excluding London market business; and
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• London market business. Our preliminary analysis indicates that the pMCR indicator could range between: • 175-200% for life business; and • 175-200% for general insurance business. We have used data from the fifth quantitative impact study, and applied it to the latest version of the MCR specification set out in the November 2011 draft Level 2 text to derive these preliminary ranges. However, to refine the calibration we will need information from UK firms and we will issue a template and instructions in September 2012. Our intention is to calibrate the indicator so that, in the vast majority of cases, firms submitting a model which properly reflects the firm’s risk profile to the standard required by the Solvency II Directive and which is approved by us will fall within the ratio or range of the indicator and so this should not be an issue for approved models on day one. Fundamentally, the purpose of the indicator is to limit subsequent downward SCR drift relative to risk profile. Since there is no MCR for groups, the ratio set out in this letter would apply to the UK solo entities.

Next steps
In addition to the request for data to refine the calibrations in September 2012, we will also provide an update on the other early warning indicators we are considering to prompt supervisory intervention, including the use of stress tests and scenarios for economy-wide variables for with-profits business and groups.
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Yours sincerely

Julian Adams Director, Insurance

_________________________________________ Solvency ii Association www.solvency-ii-association.com

16 October 2012 - Public Hearings on the draft factual Report of the EU-US Insurance Regulatory Dialogue Project
The EU-US Insurance Regulatory Dialogue Project organises two public hearings on the draft factual Report based on the results of the Project’s seven technical committees (TC). The public hearings will take place: In the USA: on 12 October 2012 at 14.00 – 17.00 hrs EDT in the Grand Hyatt, Washington DC; In Belgium: on 16 October 2012 at 10.00 – 13.00 hrs CET in the Centre de Conférences Albert Borschette, Brussels. Requests to provide oral statements during the public hearings should be sent by 10 October 2012 to the following email addresses: tom.finnell{at}treasury.gov (Washington Hearing) and Manuela.Zweimueller{at}eiopa.europa.eu (Brussels Hearing).

_________________________________________ Solvency ii Association www.solvency-ii-association.com

The EU-US Dialogue Project
The EU-US Dialogue Project started in early 2012, when the European Commission (EC), EIOPA, the US National Association of Insurance Commissioners (NAIC) and the Federal Insurance Office of the US Department of the Treasury (FIO) agreed to participate in dialogue and a related project (Project) to contribute to an increased mutual understanding and enhanced cooperation between the European Union and the United States to promote business opportunity, consumer protection and effective supervision. The objective of the Project, which builds on more than a decade of EUUS regulatory dialogue, is to deepen insight into the overall design, function and objectives of the key aspects of the insurance supervisory regimes in the EU and the U.S, and to identify important characteristics of both regimes.

Request for the EU-U.S. Dialogue Project for Public Comment on the Technical Committee Reports Comparing Certain Aspects of the Insurance Supervisory and Regulatory Regimes in the European Union and the United States
To Interested Parties: The Steering Committee of the EU-U.S. Dialogue Project invites public comment on the reports of seven technical committees comparing certain aspects of the insurance supervisory regimes in the European Union and the United States.

_________________________________________ Solvency ii Association www.solvency-ii-association.com

Introduction to the EU-U.S. Dialogue Project
In the EU, the European Parliament, the Council of the European Union and the European Commission (EC), technically supported by the European Insurance and Occupational Pensions Authority (EIOPA), are modernizing the EU’s insurance regulatory and supervisory regime through the Solvency II Directive (Directive 2009/138/EC), in place since 2009. This so-called Framework Directive was the culmination of work begun in the 1990s to update existing solvency standards in the EU. Current work aims to further specify the Framework Directive with technical rules and guidelines, which are necessary for a consistent application by insurers and supervisors of the framework. In the United States, the states are the primary regulators of the insurance industry. State insurance regulators are members of the National Association of Insurance Commissioners (NAIC), a standard-setting and regulatory support organization created and governed by the chief insurance regulators from the 50 states, the District of Columbia and five U.S. territories. As part of an evolutionary process, through the NAIC, state insurance regulators in the U.S. are currently in the process of enhancing their solvency framework through the Solvency Modernization Initiative (SMI). SMI is an assessment of the U.S. insurance solvency regulation framework and includes a review of international developments regarding insurance supervision, banking supervision, and international accounting standards and their potential use in U.S. insurance regulation.
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In early 2012, the EC, EIOPA, the NAIC and the Federal Insurance Office of the U.S. Department of the Treasury (FIO) agreed to participate in dialogue and a related project (Project) to contribute to an increased mutual understanding and enhanced cooperation between the EU and the U.S. to promote business opportunity, consumer protection and effective supervision. The project is considered to be part of and builds on the on-going EUUS Dialogue which has been in place for over 10 years. The work is carried out in collaboration with EIOPA and competent authorities in the EU Member States, and with state insurance regulators and the NAIC in the United States. The objective of the Project is to deepen insight into the overall design, function and objectives of the key aspects the two regimes, and to identify important characteristics of both regimes. Project Governance and Process: The Project is led by a six-member Steering Committee comprised of three EU and three U.S. officials, as follows: • Gabriel Bernardino – Chairman of EIOPA • Edward Forshaw – Manager in the Prudential Policy division, UK Financial Services Authority, and EIOPA Equivalence Committee Chair • Karel Van Hulle – Head of Unit for Insurance and Pensions, Directorate-General Internal Market and Services, EC • Kevin M. McCarty– Commissioner, Office of Insurance Regulation, State of Florida, and current President of the NAIC • Michael McRaith – Director, FIO, United States Department of the Treasury • Therese M. (Terri) Vaughan – Chief Executive Officer, NAIC
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Since the Project began, the Steering Committee has held several faceto-face meetings in Basel, Washington DC and Frankfurt, as well as numerous conference calls. In a first step, the topics to be discussed were agreed upon and a process for information exchange under confidentiality obligations was established. The Steering Committee agreed upon seven topics fundamentally important to a sound regulatory regime and to the protection of policyholders and financial stability. The seven topics are: • Professional secrecy/confidentiality; • Group supervision; • Solvency and capital requirements; • Reinsurance and collateral requirements; • Supervisory reporting, data collection and analysis; • Supervisory peer reviews; and • Independent third party review and supervisory on-site inspections. A separate Technical Committee (TC) was assembled to address each topic. Each TC was comprised of experienced professionals from both the European Union as well as the United States, specifically, from FIO, the EC, the NAIC and EIOPA, as well as representatives from state insurance regulatory agencies in the United States and competent authorities of EU Member States. The various professionals who comprised the technical committees were selected because of their qualifications and experience with respect to the subject matter of each topic, including insurance regulators and supervisors, attorneys, accountants, examiners, and other specialists.
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The teams worked jointly to develop objective, fact-based reports intended to summarize the key commonalities and differences between the Solvency II regime in the EU, and the state-based insurance regulatory regime in the United States. Supporting documentation, e.g., regulations, directives, and supervisory guidance, was exchanged as requested by either side. The accompanying seven technical committee reports have been jointly drafted and reflect the consensus views of each respective technical committee’s members. No action has been taken by the governing bodies of the organizations represented on the Steering Committee to formally adopt the draft factual reports and thus this document should not be considered to express official views or positions of any organization. The reports represent the culmination of the initial work from the first phase of the Project. The reports are being exposed for interested party analysis and comment and will inform discussions and conclusions reached by the Steering Committee on each topic during the second phase of the Project. It is envisaged that the second phase of the Project will involve discussions of the Steering Committee about the key commonalities and differences between the two regimes and will lead to policy decisions by their respective organizations regarding whether and how to achieve further harmonization in regulation and supervision. The project is scheduled to come to a conclusion by December 31, 2012.

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The Contributing Parties The Federal Insurance Office, U.S. Department of the Treasury
The Federal Insurance Office (FIO) of the U.S. Department of the Treasury was established by the Dodd-Frank Wall Street Reform and Consumer Protection Act. The FIO monitors all aspects of the insurance industry, including identifying issues or gaps in the regulation of insurers that could contribute to a systemic crisis in the insurance industry or the United States financial system. The FIO serves on the U.S. Financial Stability Oversight Council. The FIO coordinates and develops U.S. Federal policy on prudential aspects of international insurance matters, including representing the United States, as appropriate, in the International Association of Insurance Supervisors. The FIO assists the Secretary in negotiating certain international agreements, and serves as the primary source for insurance sector expertise within the Federal government. The FIO monitors access to affordable insurance by traditionally underserved communities and consumers, minorities, and low- and moderate-income persons. The FIO also assists the Secretary in administering the Terrorism Risk Insurance Program.

The European Commission
The European Commission (EC) is one of the main institutions of the European Union.
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It represents and upholds the interests of the EU as a whole. The EC is the executive branch of the EU and is responsible for proposing new European laws to Parliament and the Council. The EC oversees and implements EU policies by enforcing EU law (together with the Court of Justice), and represents the EU internationally, for example, by negotiating international trade agreements between the EU and other countries. It also manages the EU's budget and allocates funding. The 27 Commissioners, one from each EU country, provide the Commission’s political leadership during their 5-year term.

The National Association of Insurance Commissioners
The National Association of Insurance Commissioners (NAIC) is the standard-setting and regulatory support organization created and governed by the chief insurance regulators from the 50 states, the District of Columbia and five U.S. territories. Through the NAIC, state insurance regulators establish standards and best practices, conduct peer review, and coordinate their regulatory oversight that is exercised at the state level. NAIC staff supports these efforts and represents the collective views of state regulators domestically and internationally. NAIC members, together with the central resources of the NAIC, form the national regime of state-based insurance regulation in the United States.

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European Insurance and Occupational Pensions Authority
The European Insurance and Occupational Pensions Authority (EIOPA) was established as a result of the reforms to the structure of supervision of the financial sector in the European Union. The reform was initiated by the EC, following the recommendations of a Committee of Wise Men, chaired by Mr. de Larosière, and supported by the European Council and Parliament. EIOPA technically supports the EC, amongst others, in the modernization of the EU’s insurance regulatory and supervisory regime. Current work aims to further specify the Solvency II Framework Directive with technical rules and guidelines, which is necessary for a consistent application by insurers and supervisors of the framework. In cross-border situations, EIOPA also has a legally binding mediation role to resolve disputes between competent authorities and may make supervisory decisions directly applicable to the institution concerned. EIOPA is part of the European System of Financial Supervision consisting of three European supervisory authorities, the others being the national supervisory authorities and the European Systemic Risk Board. EIOPA is an independent advisory body to the EC, the European Parliament and the Council of the European Union. EIOPA’s core responsibilities are to support the stability of the financial system, transparency of markets and financial products as well as the protection of insurance policyholders, pension scheme members and beneficiaries.

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Annual public hearing of the chairpersons of the three European Supervisory Authorities (EBA, ESMA and EIOPA).

Initial statement by Andrea Enria Chairperson of the EBA, in front of the Economic and Monetary affairs committee of the European Parliament
Dear Madame Chair, Honourable Members of this Committee, The sovereign debt crisis has had serious adverse consequences on the banking sector in the euro area and the Single Market. The interconnection between banks and their sovereigns deepened, leading to a segmentation of the Single Market along national lines and to a dangerous volatility of deposits in some Member States. The concerns of investors translated into a freeze in bank funding, especially on the longer maturities, which could have triggered a massive and disordered deleveraging process, with potentially large effects on growth and employment. Since the second half of 2011, the EBA argued for a three-pronged approach to address this situation: (i) Strengthening banks’ capital, to put them on a stronger footing to finance the real economy and limit deleveraging; (ii) European interventions to support bank funding and break the link with the sovereigns; and (iii) Actions directly remedying the sovereign debt crisis, thus taking redenomination risk off the table. As supervisors, we tackled head on the first line of intervention, which falls directly in our remit.
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If we consider the capital injected in the system, for achieving the threshold set in the 2011 stress test, and the adjustment in capital positions triggered by our Recommendation, which asked banks to set up a Core Tier 1 buffer equal to 9% of risk weighted assets, with a prudent valuation of sovereign exposures, the overall strengthening already realised is above € 190 bn – an amount very close to the recommendation issued by the IMF in the Autumn of 2011. The support measures already approved for Greek and Spanish banks will bring the final figure further up, to a significant amount. We managed this complex process ensuring that banks did not achieve the capital target by cutting back on lending to households and corporates, especially small and medium enterprises (SMEs). We also fostered close cooperation between home and host authorities within supervisory colleges, to avoid that the possible capital adjustment was affected by a home bias. The EBA is committed to pursuing its efforts to ensure that the action of balance sheet repair continues. In this respect, supervisory coordination should take place to ensure that banks apply conservative and consistent valuation of assets and take actions to gradually restore the smooth funding of their activities in private markets. The unlimited supply of term liquidity by the ECB and by other European central banks, and the decision to move towards a Banking Union, which we strongly support, are other key components of the policy package to restore stability in the European banking sector. The Banking Union will have an impact on the responsibilities of the EBA as it will call on the whole Union for an even stronger commitment to the Single Rulebook and for a leap towards truly unified supervisory methodologies - a Single Supervisory Handbook - to assess the risks at banks and to trigger corrective actions.
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Without such an effort, we risk a polarisation of the Single Market between the euro area, with single rules and supervisory practices, and the rest of the Union, which would operate with a still wide degree of national discretion in implementing and applying the Single Rulebook. The EBA has put a lot of effort in contributing to the action of regulatory repair and the establishment of the Single Rulebook, by preparing draft standards in a number of areas defined by the proposed CRD4-CRR. At the request of the Commission, we also finalised a report on the capital requirements for SME lending, a topic that is receiving great attention also in your discussions. I believe we established a good working method, with open channels of communication with this Committee and due process of open consultation and impact assessment. This should allow us to promptly finalise our draft standards once the legislative texts are approved. In the final stage of the negotiations, it is essential that all policy makers maintain a strong commitment to rigorous and consistent rules, in line with international standards. In the EU, these rules will be applied to all banks and should therefore acknowledge the variety of business models and cultures. Proportionality will be a key concept in this respect. But in a large number of areas, it is essential that the yardsticks to assess the solvency and liquidity of banks are effectively the same for all banks in the Single Market. The strong pressure we faced to address the difficult situation in banking markets and in contributing to the reform of banking rules determined a slower start in the accomplishment of our tasks in the area of consumer protection.
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I am aware that the Parliament attaches great importance to these tasks. The urgency of making progress in this area is confirmed by the recent episodes of mis-selling, poor compliance with anti-money laundering rules and manipulation of market benchmarks. We are now working at a much higher speed in these areas and envisage issuing important guidelines in the area of mortgage lending - on responsible lending and on arrears management. Reviews of the risks for consumers and banks from financial innovations such as Exchange Traded Funds, Contacts for Differences and structured products are also being finalised. Further work is taking place under the aegis of the Joint Committee. In conclusion, let me touch on the delicate issue of resources. We really appreciate the efforts made by the Parliament to strengthen our resources. Notwithstanding the generous support provided by national supervisory authorities, which have seconded a significant number of staff at our premises during the periods of our most intense workload, it remains difficult for us to fulfil our tasks under such stringent resource constraints. While the amount of staff envisaged in the steady state situation, to be reached around 2015, is still commensurate to our tasks, there is an urgent need to accelerate the process, as the difficult challenges we are facing require that the resources are available as soon as possible. Thank you for your attention.

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EIOPA and FINMA Sign a Memorandum of Understanding
The European Insurance and Occupational Pensions Authority (EIOPA) and the Swiss Financial Market Supervisory Authority (FINMA) have signed a Memorandum of Understanding (MoU) in Bern today. The main objective of the MoU is to ensure optimal cooperation in supervision, in particular for insurance groups with international activities in the European economic area (EEA) and Switzerland. The Memorandum creates a formal basis for cooperation in the following areas: group supervision, assistance in the work of EEA and FINMA colleges of supervisors, action required in emergency situations, safeguarding financial stability by monitoring and assessing risks, interconnectedness and conducting stress tests. The Authorities would like to emphasise that the Memorandum will not modify or supersede any laws or regulatory requirements in force and will not affect any arrangements under the MoUs that have previously been signed between FINMA and other national supervisory authorities of the EEA. Anne Héritier Lachat, Chair of FINMA Board of Directors, said: “In light of the increased internationalisation of financial groups and financial products, international cooperation between supervisory authorities is gaining in importance. We are very interested in conducting an active and fruitful dialogue with key financial regulators. The MoU with EIOPA provides us with a very good basis to do so”.
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Gabriel Bernardino, Chairman of EIOPA, said: “This is the first Memorandum of Understanding ever signed by EIOPA. We are committed to pursue a constructive dialogue, effective cooperation and information exchange with FINMA. This MoU is an important step to reinforce the efficiency of supervision and to enhance consumer protection in an increasingly global insurance market”.

Note:
European Economic Area (EAA) consists of 27 EU Member States including Iceland, Liechtenstein and Norway. The Swiss Financial Market Supervisory Authority (FINMA) is an independent state supervisory authority of banks, insurance companies, exchanges, securities dealers, collective investment schemes, distributors and insurance intermediaries. The European Insurance and Occupational Pensions Authority (EIOPA) was established as a result of the reforms to the structure of supervision of the financial sector in the European Union. The reform was initiated by the European Commission, following the recommendations of a Committee of Wise Men, chaired by Mr de Larosière, and supported by the European Council and Parliament. EIOPA is part of the European System of Financial Supervision consisting of three European Supervisory Authorities, the National Supervisory Authorities and the European Systemic Risk Board. It is an independent advisory body to the European Commission, the European Parliament and the Council of the European Union. EIOPA’s core responsibilities are to support the stability of the financial system, enhance the transparency of markets and financial products, and
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protect insurance policy holders, pension scheme members and beneficiaries.

Memorandum of Understanding (MoU) between the European Insurance and Occupational Pensions Authority (EIOPA) and the Swiss Financial Market Supervisory Authority (FINMA)
(hereinafter referred to as “Authorities”) whereas, EIOPA is, under Regulation (EU) No. 1094/2010 of the European Parliament and of the Council of 24 November 2010 establishing the European Insurance and Occupational Pensions Authority (“The Regulation”), expected to ensure the orderly functioning and integrity of financial markets and the stability of the financial system in the European Union. With regard to EIOPA’s role under this MoU, Articles 8 (f) and (i), 17, 18, 21, 23, 33, 35 and 70 of The Regulation are particularly relevant. EIOPA has under The Regulation the task to pursue a constructive dialogue and effective cooperation with supervisory authorities outside the European Union. EIOPA has also the task to contribute as a competent authority to colleges of supervisors (“EEA Colleges”). EEA Colleges may also include third country subsidiaries and branches or financial groups having their headquarters in third countries and their subsidiaries or branches in the European Union. EIOPA facilitates and updates the so called Helsinki plus list which provides information on EEA insurance groups and their supervision.

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EIOPA will in its contacts with FINMA fully respect the existing roles and respective competences of the EU Member States, Liechtenstein, Iceland, Norway and the European Union institutions. This arrangement will not create legal obligations in respect of the European Union, its Member States, Liechtenstein, Iceland and Norway nor shall it prevent Member States and Liechtenstein, Iceland and Norway and their competent authorities from concluding bilateral or multilateral arrangements with FINMA. Since the tasks of EIOPA as a European Supervisory Authority are of a specific nature, a separate MoU between EIOPA and FINMA is needed. FINMA has under the Federal Act on the Swiss Financial Market Supervisory Authority (FINMASA) of 22 June 2007, notably Article 6 (2), the remit to fulfil the international tasks that are related to its supervisory activity. FINMA may, in particular, according to Article 42 FINMASA, cooperate with foreign authorities responsible for financial market supervision including the sharing of confidential information and documents. FINMA sets up and chairs supervisory colleges (“FINMA Colleges”) pursuant to its Policy on Insurance Supervisory Colleges where FINMA is the responsible group supervisor of an insurance group with international activities. In this context, FINMA is to liaise with the foreign authorities responsible for the supervision of relevant group entities. FINMA also participates where appropriate in insurance supervisory colleges organised by foreign supervisory authorities.

A. Principles and Scope
1. The purpose of this Memorandum of Understanding (MoU) is to establish a formal basis for cooperation with a view to further strengthening the dialogue and cooperation between EIOPA and
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FINMA within their respective statutory remits pertaining to insurance regulation and supervision, and more in particular regarding: • The exchange of information and assistance relating to insurance groups under group supervision of FINMA or of a supervisory authority considered a Voting Member or Observer in EIOPA’s Board of Supervisors and have business activities in the respective jurisdiction of the other authority, in particular exchange of information and assistance relating to the work of EEA and FINMA Colleges, and action required in emergency situations. • The exchange of information for macroprudential (financial stability) purposes, such as monitoring and assessment of risks, interconnectedness, and stress testing. 2. This MoU does not modify or supersede any laws or regulatory requirements in force with regard to, or applying to, FINMA or in force with regard to, or applying to, EIOPA. This MoU sets forth a statement of intent and accordingly does not create any enforceable rights. This MoU does not affect any arrangements under other MoUs. 3. The Authorities acknowledge that they may only provide information under this MoU if permitted or not prevented under applicable laws, regulations and requirements. 4. For EIOPA, all confidential information exchanged under this MoU will be subject to EIOPA’s obligation of professional secrecy (Article 70 of The Regulation and EIOPA’s confidentiality policy). 5. For FINMA, all confidential information exchanged under this MoU will be subject to FINMA’s obligation of professional secrecy (Article 14 FINMASA).

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B. Cooperation for Supervision of Insurance Groups and Conglomerates
6. The Authorities agree that the aim of cooperation is to ensure optimal supervision in particular for insurance groups with international activities in the EEA and Switzerland. The cooperation should be carried out efficiently and effectively, and should not impose unnecessary burden for the insurance undertakings subject to supervision, or for the Authorities involved. 7. The Authorities will make all reasonable efforts to exercise the cooperation and coordination in a spirit of mutual trust. 8. FINMA may participate in the activities of the EEA Colleges formed by the EEA Authorities when a Swiss insurance undertaking is concerned. In this case EIOPA Guidelines on EEA Colleges shall apply. 9. When Swiss based insurance groups with activities in the EEA are subject to group supervision by FINMA, EIOPA may participate in the activities of the FINMA colleges. In this case, the FINMA Policy on Insurance Supervisory Colleges shall apply. 10. EIOPA will facilitate information exchange between FINMA and the Supervisory Authority considered a Voting Member or Observer in EIOPA’s Board of Supervisors, in particular by making the Helsinki plus list3 accessible to FINMA. 11. FINMA will provide information to complete the Helsinki plus list4 to enable EIOPA to keep the list up to date. 12. EIOPA will in its oversight function also use information received from FINMA to prepare for the EEA College work. Only in the cases of Articles 17 and 18 of The Regulation, EIOPA may use such information for supervisory purposes.
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C. Macroprudential tasks
13. FINMA and EIOPA will share relevant information to fulfil their macroprudential tasks.

D. Procedure for Requests for Information and Assistance
14. If a request for information and assistance is made, each Authority will make reasonable efforts to provide assistance to the other, subject to its laws and overall policy. 15. Requests for the provision of information or assistance should be made in writing. In urgent cases, requests may be made orally to the usual contact persons, in summary form to be followed as soon as possible by a full request. 16. Requests for information and assistance should specify: a. the individual or aggregated information or assistance requested; b. a description of the matter which gives rise to the request; c. the purpose for which the information is sought (including details of the laws and regulatory requirements pertaining to the matter which is the subject of the request); d. the persons believed by the requesting Authority to possess the information sought, or the place where such information may be obtained, if known; e. to whom, if anyone, onward disclosure of information is likely to be necessary and the reason for such disclosure; f. the desired time period for the reply.
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Assessment of requests 17. Each request for information and assistance should be assessed on a case-by-case basis by the recipient Authority to determine whether assistance can be provided under the terms of this MoU. 18. In any case where the request cannot be fulfilled in part or whole, the recipient Authority may consider whether there may be other assistance which can be given by itself or by any other organisation in its jurisdiction. 19. In deciding whether and to what extent to fulfil a request, the recipient Authority may take into account: a. whether the request conforms with this MoU; b. whether the request involves the administration of a law, regulation or requirement which has no close parallel in the jurisdiction of the requested Authority; c. whether the provision of assistance would be so burdensome as to disrupt the proper performance of the recipient Authority’s functions; d. whether it would be otherwise contrary to the public interest or the essential national interest of the recipient Authority’s jurisdiction to give the assistance sought; e. any other matters specified by the laws, regulations and requirements of the recipient Authority’s jurisdiction (in particular those relating to confidentiality and professional secrecy, data protection and privacy, and procedural fairness); and f. whether complying with the request may otherwise be prejudicial to the performance by the recipient Authority of its functions. g. whether the request would lead to the prosecution or taking of disciplinary action or other enforcement action against a person who in the opinion of the requested Authority has already been appropriately
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dealt with in relation to the alleged breach in the subject matter of the request. 20. The Authorities recognise that assistance may be denied in whole or in part for any of the above reasons in the discretion of the recipient Authority.

Contact Points
21. The Authorities will provide a list of contact points (departments or teams in the organisation) to which information or requests for information and/or assistance under this MoU should be directed.

Costs
22. If the cost of fulfilling a request is likely to be substantial, the recipient Authority may, as a condition of agreeing to give assistance under this MoU, require the requesting Authority to make a contribution to any costs incurred.

E. Permissible Use and Confidentiality
23. If the Authorities receive confidential information under this MoU, they agree to treat such information as confidential in accordance with the provisions of this MoU. 24. An Authority that receives confidential information under this MoU may use that information for the purposes set forth in the request for information and/or assistance. 25. If the recipient Authority intends to use information provided under this MoU for any purposes other than those contemplated in paragraph 24, it will seek prior consent of the Authority providing the information. 26. The requesting Authority confirms that it will seek consent from the requested Authority before disclosing any confidential information it receives under this MoU.
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27. Before disclosing the information obtained pursuant to this MoU to third parties, the requesting Authority will seek a commitment from them to keep the information confidential. 28. The recipient Authority will undertake every effort to comply with any restrictions on the use or disclosure of information that are agreed when the information is provided. 29. If the requesting Authority is subject to a mandatory disclosure requirement or receives a legally enforceable demand for information under applicable laws, regulations and requirements, the requesting Authority will notify the requested Authority of its obligation to disclose and will endeavour to seek consent from the requested Authority before making a disclosure. If the requested Authority withholds its consent, the requesting Authority will make its best efforts to protect the confidentiality of confidential information obtained according to its confidentiality obligations stated under paragraphs 4 and 5 and, if necessary, to resist disclosure, including asserting such appropriate legal exemptions or privileges with respect to that information as may be available, for example by advising the concerned court or requesting party of the possible negative consequences of a disclosure on future co8operation between the Authorities. 30. The Authorities agree to treat the confidential information received under this MoU as confidential to the extent permitted by law even after withdrawal from this MoU under paragraph 32 below.

F. Consultation
31. The Authorities will keep the operation of this MoU under review and will consult when necessary: a. in the event of a dispute over the meaning of any term used in the MoU;

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b. in the event of a substantial change in the laws, regulations or practices affecting the operation of the MoU; c. in the event of any Authority proposing to withdraw from the MoU; and d. whenever necessary, with a view to improving its operation and resolving any matters.

G. Commencement, Withdrawal and Amendment
32. This MoU will take effect when signed. Any Authority may withdraw from the MoU by giving 30 days advance written notice to the other Authority. The MoU may be amended by agreement in writing.

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Joint Forum, Principles for the supervision of financial conglomerates Corporate Governance
Broadly, corporate governance describes the processes, policies and laws that govern how a company or group is directed, administered or controlled. It defines the set of relationships between a company’s management, its board, its shareholders, and other recognised stakeholders. Corporate governance also provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined. Good corporate governance should provide proper incentives for the board and management to pursue objectives that are in the interests of the company and its shareholders and should facilitate effective monitoring. The presence of an effective corporate governance system, within an individual company or group and across an economy as a whole, helps to provide a degree of confidence that is necessary for the proper functioning of a market economy. Financial conglomerates are often complex groups with multiple regulated and unregulated financial and other entities. Given this inherent complexity, corporate governance must carefully consider and balance the combination of interests of recognised stakeholders of the ultimate parent, and the regulated financial and other entities of the group.
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Ensuring that a common strategy supports the desired balance and that regulated entities are compliant with regulation on an individual and on an aggregate basis should be a goal of the governance system. This governance system is the fiduciary responsibility of the board of directors. When assessing corporate governance across a financial conglomerate, supervisors should apply these principles in a manner that is appropriate to the relevant sectors and the supervisory objectives of those sectors. This section describes the elements of the governance system most relevant to financial conglomerates, and how they should be assessed by supervisors.

Corporate governance in financial conglomerates
10. Supervisors should seek to ensure that the financial conglomerate establishes a comprehensive and consistent governance framework across the group that addresses the sound governance of the financial conglomerate, including unregulated entities, without prejudice to the governance of individual entities in the group.

Implementation criteria
10(a) Supervisors should require that the corporate governance framework of the financial conglomerate has minimum requirements for good governance of the entities of the financial conglomerate which allow for the prudential and legal obligations of its constituent entities to be effectively met. The ultimate responsibility for the sound and prudent management of a financial conglomerate rests with the board of the head of the financial conglomerate.

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10(b) Supervisors should require that the financial conglomerate emphasises a high degree of integrity in the conduct of its affairs. 10(c) Supervisors should seek to ensure that the corporate governance framework appropriately balances the diverging interests of constituent entities and the financial conglomerate as a whole. 10(d) Supervisors should require that the governance framework respects the interests of policy holders and depositors (where relevant), and should seek to ensure that it respects the interests of other recognised stakeholders of the financial conglomerate and the financial soundness of entities in the financial conglomerate. 10(e) Supervisors should require that the governance framework includes adequate policies and processes that enable potential intra-group conflicts of interest to be avoided, and actual conflicts of interest to be identified and managed.

Explanatory comments
10.1 The corporate governance framework should address where appropriate: • Alignment to the structure of the financial conglomerate; • Financial soundness of the significant owners; • Suitability of board members, senior management and key persons in control functions including their ability to make reasonable and impartial business judgments; • Fiduciary responsibilities of the boards of directors and senior management of the head company and material subsidiaries; • Management of conflicts of interest, in particular at the intra-group level and remuneration policies and practices within the financial conglomerate; and
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• Internal control and risk management systems and internal audit and compliance functions for the financial conglomerate. 10.2 The group’s corporate governance framework should notably include a strong risk management framework (refer to the Risk Management section), a robust internal control system, effective internal audit and compliance functions, and ensure that the group conducts its affairs with appropriate independence and a high degree of integrity. 10.3 Group-wide governance not only involves the governance of the head of the financial conglomerate, but also applies group-wide to all material activities and entities of the financial conglomerate. 10.4 In the event the local corporate governance requirements applicable to any particular material entity in the financial conglomerate are below the group standards, the more stringent group corporate governance standards should apply, except where this would lead to a violation of local law. 10.5 Supervisors should require that the corporate governance framework of the financial conglomerate includes a code of ethical conduct. 10.6 Supervisors should require that the financial conglomerate have in place policies focused on identifying and managing potential intra-group conflicts of interest, including those that may result from intra-group transactions, charges, up streaming dividends, and risk-shifting. The policies should be approved by the board of the head of the financial conglomerate and be effectively implemented throughout the group. The policies should recognise the long-term interest of the financial conglomerate as a whole, the long term interest of the significant entities of the financial conglomerate, the stakeholders within the financial conglomerate, and all applicable laws and regulations.

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Structure of the financial conglomerate
11. Supervisors should seek to ensure that the financial conglomerate has a transparent organisational and managerial structure, which is consistent with its overall strategy and risk profile and is well understood by the board and senior management of the head company.

Implementation criteria
11(a) Supervisors should understand the financial conglomerate’s group structure and the impact of any proposed changes to this structure. 11(b) Supervisors should assess the ownership structure of the financial conglomerate, including the financial soundness and integrity of its significant owners. 11(c) Supervisors should seek to ensure that the structure of the financial conglomerate does not impede effective supervision. Supervisors may seek restructuring under appropriate circumstances to achieve this, if necessary. 11(d) Supervisors should seek to ensure that the board and senior management of the head of the financial conglomerate are capable of describing and understanding the purpose, structure, strategy, material operations, and material risks of the financial conglomerate, including those of unregulated entities that are part of the financial conglomerate structure. 11(e) Supervisors should assess and monitor the financial conglomerate's process for approving and controlling structural changes, including the creation of new legal entities. 11(f) Where the financial conglomerate is part of a wider group, supervisors should require that the board and senior management of the head of the financial conglomerate have governance arrangements that enable material risks stemming from the wider group structure to be identified and appropriately assessed by relevant supervisory authorities.
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11(g) Supervisors should seek to ensure that there is a framework governing information flows within the financial conglomerate and between the financial conglomerate and entities of the wider group (eg reporting procedures).

Explanatory comments
11.1 A financial conglomerate may freely set its functional, hierarchical, business and/or regional organisation, provided all entities within the financial conglomerate comply with their relevant sectoral and legal frameworks. 11.2 Elements to be considered for assessing the significant ownership structure of the financial conglomerate may include the identification of significant owners, including the ultimate beneficial owners, the transparency of their ownership structure, their financial information, and the sources of their initial capital and all other requirements of national authorities. At a minimum, the necessary qualities of significant owners relate to the integrity demonstrated in personal behaviour and business conduct, as well as to the ability to provide additional support when needed. 11.3 Supervisors should seek to ensure that a financial conglomerate has an organisational and managerial structure that promotes and enables prudent management, and if necessary, orderly resolution aligned with corresponding sectoral requirements. Reporting lines within the financial conglomerate should be clear and should facilitate information flows within the financial conglomerate, both bottom-up and top-down. 11.4 Supervisors should be satisfied that the board and senior management of the head of the financial conglomerate understand and influence the evolution of an appropriate group legal structure in alignment with the approved business strategy and risk profile of the
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financial conglomerate, and understand how the various elements of the structure relate to one another. Where a financial conglomerate creates many legal entities, their number and, particularly, the interconnections and transactions between them, may pose challenges for the design of effective corporate governance arrangements. This risk should be recognised and managed. This is particularly the case where the organisational and managerial structure of the financial conglomerate deviates from the legal entity structure of the financial conglomerate. 11.5 Supervisors should assess changes to the group structure and how these changes impact its soundness, especially where such changes cause the financial conglomerate to engage in activities and/or operate in jurisdictions that impede transparency or do not meet international standards stemming from sectoral regulation.

Suitability of board members, senior managers and key persons in control functions
12. Supervisors should seek to ensure that the board members, senior managers and key persons in control functions in the various entities in a financial conglomerate possess integrity, competence, experience and qualifications to fulfil their role and exercise sound objective judgment.

Implementation criteria
12(a) Supervisors should be satisfied of the suitability of board members, senior managers and key persons in control functions. 12(b) Supervisors should require financial conglomerates to have satisfactory processes for periodically assessing suitability.
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12(c) Supervisors should require that the members of the boards of the head of the financial conglomerate and of its significant subsidiaries act independently of parties and interests external to the wider group; and that the board of the head of the financial conglomerate include a number of members acting independently of the wider group (including owners, board members, executives, and staff of the wider group). 12(d) Supervisors should communicate with the supervisors of other regulated entities within the conglomerate when board members, senior management and key persons in control functions are deemed not to meet their suitability tests.

Explanatory comments
12.1 Board members, senior managers and key persons in control functions need to have appropriate skills, experience and knowledge, and act with care, honesty and integrity, in order to to make reasonable and impartial business judgments and strengthen the protection afforded to recognised stakeholders. To this end, institutions need to prudently manage the risk that persons in positions of responsibility may not be suitable. Suitability criteria may vary depending on the degree of influence on or the responsibilities for the financial conglomerate. 12.2 Supervisors of regulated entities of the financial conglomerate are subject to statutory and other requirements in applying suitability tests to these entities in their jurisdiction. The organisational and managerial structure of financial conglomerates adds elements of complexity for supervisors seeking to ensure the suitability of persons.

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For instance, the management of regulated entities within the financial conglomerate can be extensively influenced by persons who are not directly responsible for such functions. A group-wide perspective regarding suitability of persons is intended to close any loopholes in this respect. Supervisors may rely on assessments made by other relevant supervisors in this area regarding suitability. Alternatively they may decide on concerted supervisory actions regarding suitability if required. 12.3 In order to meet suitability requirements, board members, senior managers and key persons in control functions, both individually and collectively, should have and demonstrate the ability to perform the duties or to carry out the responsibilities required in their position. Competence can generally be judged from the level of professionalism (eg pertinent experience within financial industries or other businesses) and/or formal qualifications. 12.4 Serving as a board member or senior manager of a company (from the wider group) that competes or does business with the regulated entities in the financial conglomerate can compromise independent judgment and create conflicts of interest, as can cross-membership on boards. A board’s ability to exercise objective judgment independent of the views of executives and of inappropriate political or personal interests can be enhanced by recruiting members from a sufficiently broad population of candidates. The key characteristic of independence is the ability to exercise objective, independent judgment after fair consideration of all relevant information and views without undue influence from executives or from
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inappropriate external parties and interests and while taking into account the requirements of applicable law.

Responsibility of the board of the head of the financial conglomerate
13. Supervisors should require that the board of the head of the financial conglomerate appropriately defines the strategy and risk appetite of the financial conglomerate, and ensures this strategy is implemented and executed in the various entities, both regulated and unregulated.

Implementation criteria
13(a) Supervisors should require that the board of the head of the financial conglomerate has in place a framework for monitoring compliance with the strategy and risk appetite across the financial conglomerate. 13(b) Supervisors should require that the board of the head of the financial conglomerate regularly assesses the strategy and risk appetite of the financial conglomerate to ensure it remains appropriate as the conglomerate evolved. 13(c) Where the financial conglomerate is part of a wider group, supervisors should assess whether the head is managing its relationship with the wider group and ultimate parent in a manner that is consistent with the governance framework of the financial conglomerate. 13(d) Supervisors should require that a framework is in place which seeks to ensure resources are available across the financial conglomerate for constituent entities to meet both the group and their own entity’s governance standards.

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Explanatory comments
13.1 Supervisors should assess if the board of directors exercises adequate oversight over the management of the head of the financial conglomerate. This includes assessing the actions taken by the board of the head to define the strategy for the financial conglomerate and ensure the consistency of the operations of the various entities in the financial conglomerate with such strategy. To this end, the head company should set up an adequate corporate governance framework in line with the structure, business and risks of the financial conglomerate and its entities and applicable laws. This framework should ensure that the strategy is implemented and monitored throughout the financial conglomerate and reviewed on a regular basis and following material change including due to growth, increased complexity, geographic expansion, etc. 13.2 The head company should exercise adequate oversight of subsidiaries, both regulated and unregulated, while respecting independent legal and governance responsibilities. Supervisors should satisfy themselves that entities within a financial conglomerate adhere to the same group-wide corporate governance principles or at least apply policies that remain consistent with these principles. The board of a regulated subsidiary of a financial conglomerate will retain and set its own corporate governance responsibilities and practices in line with its own legal requirements or in proportion to its size or business. These should not, however, conflict with the broader financial conglomerate corporate governance framework.
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Appropriate governance arrangements will address arrangements such that legal or regulatory provisions or prudential rules of regulated subsidiaries will be known and taken into account by the head company. 13.3 Where the financial conglomerate is part of a wider group structure, the head of the financial conglomerate is responsible for managing the relationship with its wider group. This includes ensuring there are appropriate arrangements for capital and liquidity management, assessing any material risk impact that may come from decisions made at its ownership level, service level agreements, reporting lines and regular top-level consultations with related companies in the wider group and the ultimate parent. 13.4 For smaller institutions within a larger conglomerate, it may be unnecessary to duplicate systems and controls. Such smaller institutions can rely on the systems and controls of the head if they have assessed that this is suitable to address group risks. 13.5 Supervisors should be satisfied with the amount and quality of information they receive from the head company of the financial conglomerate on its strategy, risk appetite and corporate governance framework.

Remuneration in a financial conglomerate
14. Supervisors should require that the financial conglomerate has and implements an appropriate remuneration policy that is consistent with its risk profile. The policy should take into account the material risks that organisation is exposed to, including those from its employees’ activities.

Implementation criteria
14(a) Supervisors should require that an appropriate remuneration policy consistent with established international standards is in place and
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observed at all levels and across jurisdictions in the financial conglomerate. An appropriate policy aligns risk-takers’ variable remuneration with prudent risk taking, promotes sound and effective risk management, and takes into account any other appropriate factors. The overarching objective of the policy should be consistent across the group but can allow for reasonable differences based on the nature of the constituent entities/units and local legal requirements. 14 (b) Supervisors should require that ultimate oversight of the remuneration policy rest with the financial conglomerate’s head company. 14(c) Supervisors should require that the remuneration of board members, senior managers and key persons in control functions be determined in a manner that does not incentivise them to disregard the obligations they owe to the financial conglomerate or any of its entities, nor to otherwise act in a manner contrary to any legal or regulatory obligations. 14(d) Supervisors should require that the risks associated with remuneration are reflected in the financial conglomerate’s broader risk management framework. For example, staff engaged in financial and risk control at the groupwide level should be compensated in a manner that is consistent with their control role and should be involved in designing incentive arrangements, and assessing whether such arrangements encourage imprudent risk-taking. 14(e) Supervisors should require that the variable remuneration received by risk management and control personnel is not based substantially on the financial performance of the business units that they review but rather on the achievement of the objectives of their functions (eg adherence to internal controls).
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Explanatory comments
14.1 Remuneration is a key aspect of any governance framework and needs to be properly considered in order to mitigate the risks that may arise from poorly designed remuneration arrangements. The risks associated with remuneration should be reflected in the financial conglomerate’s broader risk management framework. 14.2 Remuneration may serve important objectives, including attracting skilled staff, promoting better organisation-wide and employee performance, promoting retention, providing retirement security and allowing personnel costs to vary with revenues. It is also clear, however, that ill-designed compensation arrangements can provide incentives to take risks that are not consistent with the long term health of the organisation. Such risks and misaligned incentives are of particular supervisory interest. 14.3 Ultimately a financial conglomerate’s remuneration policy should aim to ensure effective governance of remuneration, alignment of remuneration with prudent risk-taking, and engagement of recognised stakeholders. 14.4 Supervisors should ensure that the governance system identifies and closes loopholes that allow the circumvention of conglomerate, sectoral or entity-level remuneration requirements. 14.5 Board members, senior managers and key persons in control functions should be measured against performance criteria tied not only to the short-term, but also to the long-term interest of the financial conglomerate as a whole.

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V. Risk Management
Since financial conglomerates are in the business of risk-taking, good risk management is a crucial focus of supervision. This section provides principles for the sound and comprehensive supervision of risk management frameworks in financial conglomerates. It covers factors ranging from risk culture and tolerance, to the use of stress and scenario testing and the monitoring of risk concentrations.

Risk management framework
21. Supervisors should require that an independent, comprehensive and effective risk management framework, accompanied by a robust system of internal controls, effective internal audit and compliance functions, is in place for the financial conglomerate.

Implementation criteria
21(a) Supervisors should ensure that the risk management framework is comprehensive, consistent across entities supervised in all sectors and covers the risk management function, risk management processes and governance, and systems and controls.

Risk management function
21(b) Supervisors should require that the risk management function is independent from the business units and has a sufficient level of authority and adequately skilled resources to carry out its functions. 21(c) Supervisors should require that the risk management function generally has a direct reporting line to the board and senior management of the financial conglomerate. 21(d) Supervisors should, where they consider it appropriate, require that a separate risk management committee at the board of directors level is
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established by the financial conglomerate.

Risk management governance
21(e) Supervisors should require that the board of the head of the financial conglomerate has overall responsibility for the financial conglomerate’s group-wide risk management, internal control mechanism, internal audit and compliance functions to ensure that the group conducts its affairs with a high degree of integrity. 21(f) Supervisors should require that the financial conglomerate has an established enterprise-wide risk management process for, among others, periodically reviewing the effectiveness of the group-wide risk management framework and for ensuring appropriate aggregation of risks. 21(g) Supervisors should require that the risk management process cover identification, measurement, monitoring and controlling of risk types (eg credit risk, operational risk, strategic risk, liquidity risk) and these be linked where appropriate to specific capital requirements.

Systems and controls
21(h) Supervisors should require that financial conglomerates have in place adequate, sound and effective risk management processes and internal control mechanisms at the level of the financial conglomerate, including sound administrative and accounting procedures. 21(i) Supervisors should require that risk management processes and internal control mechanisms of a financial conglomerate are appropriately documented and, at a minimum, take into account the: • nature, scale and complexity of its business; • diversity of its operations, including geographical reach ;
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• volume, frequency and size of its transactions; • degree of risk associated with each area of its operation; • interconnectedness of the entities within the financial conglomerate (using intra-group transactions and exposures reporting as one measure); and • sophistication and functionality of information and reporting systems.

Explanatory comments
21.1 Financial conglomerates, irrespective of their particular mix of business lines or financial sectors, are in the business of risk taking. Therefore, strong risk management is of paramount importance. 21.2 The comprehensive risk management framework and process should include board and senior management oversight. 21.3 In identifying, evaluating, monitoring, controlling and mitigating material risks (from regulated and unregulated activities), financial conglomerates should consider the prospect for these to change over time and prepare themselves accordingly. 21.4 The risk management processes and internal control mechanisms of a financial conglomerate should include clear arrangements for delegating authority and responsibility; segregation of the functions that involve committing the financial conglomerate’s funds and accounting for assets and liabilities; reconciliation of these processes; safeguarding of the financial conglomerate’s assets; and appropriate independent internal audit and compliance functions to test adherence to these controls as well as applicable laws and regulations.

Risk tolerance levels and risk appetite policy
23. Supervisors should require that the financial conglomerate
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establishes appropriate board approved, group-wide risk tolerance levels and a risk appetite policy.

Implementation criteria
23(a) Supervisors should require that key staff, senior management and the board of the head of the financial conglomerate be aware of and understand the financial conglomerate’s risk tolerance levels and risk appetite policy. 23(b) Supervisors should require that the financial conglomerate identify and measure against risk tolerance limits (and in line with its risk appetite policy) the risk exposure of the financial conglomerate on an on-going basis in order to identify potential risks as early as possible. This may include looking at risks by territory, by line of business, or by financial sector.

Explanatory comments
23.1 Financial conglomerates should establish risk tolerance levels and a risk appetite policy which set the tone for acceptable and unacceptable risk taking. This should be aligned with the financial conglomerate’s business strategy, risk profile and capital plan. 23.2 A financial conglomerate’s risk tolerance should be kept under periodic review so as to ensure that it remains relevant and takes account of the changing dynamics of the financial conglomerate. The financial conglomerate’s risk appetite policy is re-assessed regularly with respect to new business opportunities, changes in risk capacity and tolerance, and operating environment.

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New business
24. Supervisors should require that the financial conglomerate carries out a robust risk assessment when entering into new business areas.

Implementation criteria
24(a) Supervisors should, where they consider it appropriate, review the risk assessment carried out by a financial conglomerate in the context of entering into new business. 24(b) Supervisors should require that financial conglomerates not expand into new products unless they have put in place adequate processes, controls and systems (such as IT) to manage them. 24(c) Supervisors should make sure that a financial conglomerate carries out the ongoing risk assessment after entering into new business areas.

Explanatory comments
24.1 At the time of assessing whether or not to enter into a new business area or product line, it is imperative that financial conglomerates undertake risk assessments and analyses to identify potential risks inherent in the new activity. 24.2 They should seek to understand the potential interaction between the risks of the new activity and the existing risk profile of the financial conglomerate. This should include a consideration of whether the new activity could adversely affect the risk appetite or risk tolerance of the financial conglomerate.

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Outsourcing
25. Supervisors should require that, when considering whether to outsource a particular function, the financial conglomerate carries out an assessment of the risks of outsourcing, including the appropriateness of outsourcing a particular function.

Implementation criteria
25(a) Supervisors should require that financial conglomerates have processes and criteria in place to review decisions to outsource a function in order to ensure that such outsourcing does not imply delegation of responsibility for that function. 25(b) Supervisors should be satisfied that the decision to outsource a function does not impede effective group-wide supervision of the financial conglomerate.

Explanatory comments
25.1 It is important that supervisors be satisfied that, when considering whether to outsource a particular function, financial conglomerates have considered the risks involved and the appropriateness of outsourcing a particular function. This includes considering the appropriateness of outsourcing to a particular provider and the cumulative risks of all outsourced functions. The supervisor should require the financial conglomerate to review the provider in advance to ensure it is in a position to provide the services, comply with the contractual terms, and observe all applicable laws and regulations. 25.2 Supervisors should periodically assess the outsourced function with regard to policy compliance, risk management measures and control procedures.
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25.3 Outsourcing should never result in a delegation of responsibility for a given function. There may be certain functions within financial conglomerates which should not be outsourced under any circumstances, while there may be some that may only be outsourced if certain safeguards are put in place.

Stress and scenario testing
26. Supervisors should require, where appropriate, that the financial conglomerate periodically carries out group-wide stress tests and scenario analyses for its major sources of risk.

Implementation criteria
26(a) Supervisors should require that stress tests are sufficiently severe, forward looking and flexible. They should cover an appropriate set of business activities and include a variety of different types of tests such as sensitivity analyses, scenario analyses and reverse stress testing. 26(b) Supervisors should require the financial conglomerate to document its stress and scenario tests, including reverse stress tests. Stress tests should be conducted under a robust governance framework that encompasses policies, procedures, and adequate documentation of procedures as well as validation of results. 26(c) Supervisors should require that the group-wide stress tests and scenario analyses conducted by the financial conglomerate are appropriate to the nature, scale and complexity of those major sources of risk and to the nature, scale and complexity of the financial conglomerate’s business.

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26(d) Supervisors should require that group-wide stress tests and scenario analyses include a group-wide approach (which takes account of the interaction between different parts of the group and different risk types) and consider the results of sectoral stress tests. 26(e) Supervisors should require that, when carrying out reverse stress tests, a financial conglomerate identifies a range of adverse circumstances which would cause its business to fail and assess the likelihood of such events crystallising.

Explanatory comments
26.1 A financial conglomerate should have a good understanding of correlation between its respective sectors and the heterogeneity of such risks when conducting its stress tests. Stress tests should be robust and should consider sufficiently adverse circumstances. The group-wide stress test analysis should measure and evaluate the potential impact on individual entities. 26.2 Attention should be paid to covering all risks, including off-balance sheet items. For example, a financial conglomerate’s stress tests and scenario analyses should take into account the risk that the financial conglomerate may have to bring back on to its consolidated balance sheet the assets and liabilities of off-balance sheet entities as a result of reputational contagion, notwithstanding the appearance of legal risk transfer. 26.3 Where reverse stress tests reveal a risk of business failure that is unacceptably high relative to the financial conglomerate’s risk appetite or risk tolerance, the financial conglomerate should evaluate and adopt,
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where appropriate, effective arrangements, processes, systems or other measures to prevent or mitigate that risk.

Risk aggregation
27. Supervisors should require that the financial conglomerate aggregate the risks to which it is exposed in a prudent manner.

Implementation criteria
27(a) Supervisors should require that financial conglomerates ***not make overly ambitious diversification assumptions*** or imprudent correlation claims, particularly for capital adequacy and solvency purposes. 27(b) Supervisors should require financial conglomerates to have adequate resources and systems (including IT) for the purpose of aggregating risks.

Explanatory comments
27.1 Risk aggregation should include a clear understanding of assumptions and be robust enough to support a comprehensive assessment of risk. 27.2 While it is possible that the spread of activities within a financial conglomerate may create diversification effects and reduce correlation, it is also true that membership of a financial conglomerate group may create “group risks” in the form of financial contagion, reputational contagion, ratings contagion (where a subsidiary accesses capital through a parent’s credit rating and then suffers stress following the utilisation of the capital), double/multiple-gearing (use of same capital more than once within a group), excessive leveraging (upgrade in the quality of capital as it moves through a group), and regulatory arbitrage (it is important that risks are assessed at the financial conglomerate level as well as at the level of its constituent parts).
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Risk concentrations and intra-group transactions and exposures
28. Supervisors should require that the financial conglomerate has in place effective systems and processes to manage and report group-wide risk concentrations and intra-group transactions and exposures.

Implementation criteria
28(a) Supervisors should require that the financial conglomerate has in place effective systems and processes to identify, assess and report group-wide risk concentrations (including for the purposes of monitoring and controlling those concentrations). 28(b) Supervisors should require that the financial conglomerate has in place effective systems and processes to identify, assess and report significant intra-group transactions and exposures. 28(c) Supervisors should require the financial conglomerate to report significant risk concentrations and intra-group transactions and exposures at the level of the financial conglomerate on a regular basis. 28(d) Supervisors should consider setting quantitative limits and adequate reporting requirements.

Explanatory comments
28.1 Supervisors should ensure that financial conglomerates are managing their risk concentrations and intra-group transactions and exposures satisfactorily. 28.2 Supervisors should encourage adequate public disclosure of risk concentrations and intra-group transactions and exposures. 28.3 Supervisors should liaise closely with one another to ascertain each other’s concerns and coordinate as deemed appropriate any supervisory
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action relative to risk concentrations and intra-group transactions and exposures within the financial conglomerate. 28.4 Supervisors should deal effectively with material risk concentrations and intra-group transactions and exposures that are considered to have a detrimental effect on the regulated entities or the financial conglomerate as a whole.

Off-balance sheet activities
29. Supervisors should require that off-balance sheet activities, including special purpose entities, are brought within the scope of group-wide supervision of the financial conglomerate, where appropriate.

Implementation criteria
29(a) Supervisors should require that there is a process for determining whether the nature of the relationship between the financial conglomerate and a special purpose entity (SPE) requires the SPE to be fully or proportionally consolidated into the financial conglomerate for regulatory purposes. 29(b) Supervisors should require that the financial conglomerate’s stress tests and scenario analyses take into account the risk associated with off balance sheet activities. 29(c) Supervisors should require that the overall nature of the relationship between the financial conglomerate and the SPE is considered including the risk of contagion from the SPE. This assessment should go beyond traditional control and influence relationships.

Explanatory comments
29.1 A financial conglomerate’s risk management framework and processes should cover the full spectrum of risks to the financial conglomerate. This includes risks from regulated and unregulated entities, including SPEs and off-balance sheet activities.
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29.2 The fact that a financial conglomerate does not own or control the SPE in the traditional sense should not mean that it should not be consolidated. Other channels of contagion should be considered, such as the provision of (actual or contingent) liquidity support, reputational risk, and whether the assets of the SPE previously belonged to the financial conglomerate or were third-party assets. 29.3 It is important that financial conglomerates assess all economic risks and business purposes of an SPE throughout the life of a transaction, distinguishing between risk transfer and risk transformation. Financial conglomerates should be particularly aware that, over time, the nature of these risks can change. Supervisors should require such assessment to be ongoing and that management has sufficient understanding of the risks. 29.4 Financial conglomerates should have the capability to aggregate, assess and report all their SPE exposure risks in conjunction with all other firm-wide risks. 29.5 Supervisors should regularly oversee and monitor the use of all SPE activity and assess the implications for the financial conglomerate of the activities of SPEs, in order to identify developments that can lead to systemic weakness and contagion or that can exacerbate pro-cyclicality.

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Solvency II Speakers Bureau
The Solvency II Association has established the Solvency II Speakers Bureau for firms and organizations that want to access the expertise of Certified Solvency ii Professionals (CSiiPs) and Certified Solvency ii Equivalence Professionals (CSiiEPs). The Solvency II Association will be the liaison between our certified professionals and these organizations, at no cost. We strongly believe that this can be a great opportunity for both, our certified professionals and the organizers. To learn more: www.solvency-ii-association.com/Solvency_II_Speakers_Bureau.html

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Course Title Certified Solvency ii Professional (CSiiP): Preparing for the Solvency ii Directive of the EU (3 days)
Objectives: This course has been designed to provide with the knowledge and skills needed to understand and support compliance with the Solvency ii Directive of the European Union. Target Audience: This course is intended for decision makers, managers, professionals and consultants that: A. Work in Insurance or Reinsurance firms of EEA countries. B. Work in Groups - Financial Conglomerates (FC), Financial Holding Companies (FHC), Mixed Financial Holding Companies (MFHC), Insurance Holding Companies (IHC) - providing insurance and/or reinsurance services in the EEA, whose parent is located in a country of the EEA. C. Want to understand the challenges and the opportunities after the Solvency ii Directive. This course is highly recommended for supervisors of EEA countries that want to understand how countries see Solvency II as a Competitive Advantage. This course is also recommended for all decision makers, managers, professionals and consultants of insurance and/or reinsurance firms involved in risk and compliance management.

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About the Course INTRODUCTION  The European Union’s Legislative Process  Directives and Regulations  The Financial Services Action Plan (FSAP) of the EU  Extraterritorial Application of European Law  Extraterritorial Application of the Solvency II Directive  Solvency ii and the Lamfalussy Process  Level 1: Framework Principles  Level 2: Detailed Technical MeasuresLevel 3: Strengthening Cooperation Among Regulators  Level 4: Enforcement  Weaknesses of Solvency I  From Solvency I to Solvency II  Solvency ii Players  Solvency ii Objectives THE SOLVENCY II DIRECTIVE  A Unified Legislative Basis for Prudential Regulation of Insurers and Reinsurers  Risk-Based Capital Allocation  Scope of the Application  Important Definitions  Value-at-Risk in Solvency II  Authorisation  Corporate Governance  Governance Functions  Risk Management  Corporate Governance and Risk Management - Level 2  Fit and proper requirements for persons who effectively run the undertaking or have other key functions  Internal Controls
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    

Internal Audit Actuarial Function Outsourcing Board of Directors: Role and Solvency ii Responsibilities 12 Principles – System of Governance (Level 2)

PILLAR 2  Supervisory Review Process (SRP)  Focus on Risk Management and Operational Risk  Own Risk and Solvency Assessment (ORSA)  ORSA - The Internal Assessment Process  ORSA - The Supervisory Tool  ORSA - Not a Third Solvency Capital Requirement  Capital add-on PILLAR 3  Disclosure Requirements  The Solvency and Financial Condition Report (SFC) PILLAR I  Valuation Of Assets And Liabilities Technical Provisions  The Solvency Capital Requirement (SCR)  The Value-at-Risk Measure Calibrated to a 99.5% Confidence Level over a 1-year Time Horizon  The Standard Approach  The Internal Models  The Collection of Additional Historical Data  External Data  The Minimum Capital Requirement (MCR)  Non-Compliance with the Minimum Capital Requirement  Non-Compliance with the Solvency Capital Requirement  Own Funds  Investment Rules
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INTERNAL MODEL APPROVAL  CEIOPS Level 2 - Tests and Standards for Internal Model Approval  CEIOPS Level 2 - The procedure to be followed for the approval of an internal model  Internal Models Governance  Group internal models  Statistical quality standards  Calibration and validation standards  Documentation standards SOLVENCY II, GROUP SUPERVISION AND THIRD COUNTRIES  Solvency I: Solo Plus Approach  Group Supervision under Solvency II  Rights and duties of the group supervisor  Group Solvency - Methods of calculation  Method 1 (Default method): Accounting consolidation-based method  Method 2 (Alternative method): Deduction and aggregation method  Parent Undertakings Outside the Community - Verification of Equivalence  Parent Undertakings Outside the Community - Absence of Equivalence  The head of the group is in the EEA and the third country regime is not equivalent  The head of the group is in the EEA and the third country regime is equivalent  The head of the group is outside the EEA and the third country is not equivalent  The head of the group is outside the EEA and the third country regime is equivalent  Small and Medium-Sized Insurers: The Proportionality Principle  Captives and Solvency II
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EQUIVALENCE WITH SOLVENCY II AROUND THE WORLD  Solvency ii and Countries outside the European Economic Area  The International Association of Insurance Supervisors (IAIS)  The Swiss Solvency Test (SST) and Solvency ii:  Solvency ii and the Offshore Financial Centers (OFCs)  Solvency ii and the USA  Solvency ii and the US National Association of Insurance Commissioners (NAIC) - The Federal Insurance Office created under the Dodd-Frank Wall Street Reform and Consumer Protection Act in the USA, and the ORSA in the USA FROM THE REINSURANCE DIRECTIVE TO THE SOLVENCY II DIRECTIVE  Directive 2005/68/EC of 16 November 2005 on Reinsurance - The Reinsurance Directive (RID) CLOSING  The Impact of Solvency ii Outside the EEA  Providing Insurance Services to the European Client  Competing with Banks  Learning from the Basel ii Framework  Regulatory Arbitrage: A Major Risk for Countries that see Compliance as an Obligation, not an Opportunity  Basel II, Basel III, Solvency II and Regulatory Arbitrage  Challenges and Opportunities: What is next  Regulatory Shopping after Solvency II To learn more about the course: www.solvency-ii-association.com/Certified_Solvency_ii_Training.htm

_________________________________________ Solvency ii Association www.solvency-ii-association.com

_________________________________________ Solvency ii Association www.solvency-ii-association.com