Download Discussion Document 92 (v 8) Assessment of Group Solvency

Solvency Assessment and Management: Pillar I - Sub Committee
Insurance Groups Task Group
Discussion Document 92 (v 8)
Assessment of Group Solvency
1. INTRODUCTION AND PURPOSE
A group-wide solvency assessment involves assessing whether management of risk and
capital for an insurance group is adequate, especially to the extent that the group conducts
activities that may adversely affect the financial / solvency position of insurance entities within
the group. It covers other important issues such as investments in related entities, intra-group
transactions, risk exposures and double gearing of capital. The Solvency II level I text uses as
a basis for group solvency supervision the requirement that eligible own funds must be at
least equal to the group solvency capital requirement.
The following was included as interim measure for the group-wide solvency:
An insurance group or insurance sub-group shall at all times maintain its business in a
financially sound condition by managing its affairs in such a way that the aggregate of the
qualified capital of the group does not at any time amount to less than the aggregate of the
required capital determined, after the elimination of investments in one another. Failure to
maintain a financially sound group-wide solvency will result in appropriate regulatory actions
and/or enforcement or sanctions.
This discussion document further evaluates the recommendations made on the assessment
of group solvency by the Insurance Group Task Group in their discussion document for the
interim measure on Insurance Groups (DD1).
2. INTERNATIONAL STANDARDS: IAIS ICPs
IAIS ICP 17: The supervisory regime establishes capital adequacy requirements for
solvency purposes so that insurers can absorb significant unforeseen losses and to
provide for degrees of supervisory intervention.
Solvency Assessment and Management: Pillar I - Sub Committee – Insurance Groups Task Group
Discussion Document 92 (v 8) – Assessment of Group Solvency
IAS ICP 23: The supervisory authority supervises its insurers on a legal entity and a groupwide basis. The Group-wide Supervision Framework (“GSF”) is included in ICP 23. The
ultimate objective of group-wide supervision is to promote effective supervision of insurance
groups. The establishment of the GSF is expected to facilitate appropriately streamlined,
consistent and effective group-wide supervision – supporting a supervisory framework that
preserves the standards of protection of policyholders and maintains the soundness of each
insurer and overall financial stability, as well as avoiding unnecessary overlaps and material
deficiencies, and unnecessary burden for the industry.
3. EU DIRECTIVE ON SOLVENCY II: PRINCIPLES (LEVEL 1)
The following paragraphs provide a brief synopsis of the main topics and features covered
by articles 220 to 233 that are relevant to this discussion document:
Article 220 details the choice of the calculation method for the group SCR. The Accounting
Consolidation-based method is the default method. The group supervisor shall be able to
require, after consultation with the other supervisory authorities in the college and the
group itself, the use of the deduction-aggregation method or a combination of both
methods when the default method is not appropriate.
Article 221 deals with the interpretation of the concept of the "proportional share" of
related undertakings to be included in the calculation. This includes the recognition of solo
solvency deficits at group level and includes an explicit power for the group supervisor to
set the proportional share in some cases (dominant or significant influence determined by
the supervisory authorities and absence of capital ties). The absence of capital ties often
refers to mutual undertakings.
Article 222 ensures there are no double use of own funds and addresses the eligibility of
own funds at group level taking into account potential availability constraints.
Article 223 ensures that the intra-group creation of capital is eliminated when calculating
group solvency.
Article 224 states that the valuation principles that apply at solo level also apply at group
level. It allows Member States to use the solvency figures calculated in other Member
States.
Article 225 ensures that all related (re)insurance undertakings are included in the group
calculations.
Article 226 accounts for the inclusion of intermediate insurance holding companies in the
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group calculations.
Article 227 details the equivalence assessment process for third country regimes for the
purposes of the deduction and aggregation method.
Article 228 accounts for the treatment of related credit institutions, investment firms and
financial institutions when calculating group solvency and allows their inclusion unless their
deduction is decided by the group supervisor.
Article 229 provides for the deduction of the book value of a related undertaking if the
information necessary for calculating the group solvency of its participating undertaking is
not available.
Article 230 describes the default method for the group calculations, the Accounting
consolidation-based method, including the minimum consolidated group SCR.
Article 231 describes the approval process for a group internal model and the application
of a solo capital add-on in the context of a group internal model. The approval process for a
group internal model is covered in the advice on the approval of an internal model.
Article 232 deals with the application, when the consolidation method is used, of capital
add-ons at group level. That advice includes the description of issues related to group
specific risks. The setting of a capital add-on at group level is covered in CEIOPS advice
on capital add-ons.
Article 233 describes the deduction and aggregation method for the group calculations,
including the imposition of a capital add-on to the aggregated group SCR.
4. MAPPING ANY PRINCIPLE (LEVEL 1) DIFFERENCES BETWEEN IAIS ICP &
EU DIRECTIVE
The Solvency II Directive and the ICP principles are in agreement that Insurance Groups
should form part of the Regulator‟s supervision and that the Insurance Groups must be solvent
as a whole.
5. STANDARDS AND GUIDANCE
5.1 Insurance groups Interim Measures
The following recommendations were made as part of the Interim Measures for the
assessment of group solvency:

An insurance group or insurance sub-group shall at all times maintain its business
in a financially sound condition by managing its affairs in such a way that the
aggregate of the qualified capital of the group does not at any time amount to less
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than the aggregate of the required capital determined, after the elimination of
investments in one another. Failure to maintain a financially sound group -wide
solvency will result in appropriate regulatory actions and/or enforcement or
sanctions.

Further to this, the definitions for qualifying capital and capital requirement was
highlighted;

Assets and liabilities of group entities will be determined in terms of the rules and
regulations of the Regulator responsible for the solo supervision of the entity;

The task group recommends the deduction and aggregation method for the interim
measures; and

For capital-add on, the FSB has the right after consultation with the insurer to
impose a capital add-on where the risks including those posed by the nonregulated entities are not adequately taken into account in the group capital
adequacy or the deduction of the value of holdings in non-regulated entities from
the capital resources of the insurance legal entities in the group.
5.2 IAIS standards and guidance papers: ICP 23 Group-wide supervision:
ICP23 establishes the fundamental requirements for supervision on a group-wide basis. The
fundamental requirements are based on the GSF.
With regard to the level 2 group-wide regulatory requirements, at a minimum, the group-wide
supervision framework should include, as a supplement to legal entity supervision,
• Extension of legal entity requirements, as applicable according to the relevant ICPs, on:
 Solvency assessment (group-wide solvency);
 Governance, risk management and internal controls (group-wide governance);
 Market conduct (group-wide market conduct)
The IAIS’s issues paper on group-wide solvency assessment and supervision issued March 2009,
specifically details solvency assessment and included the following:
Capital adequacy
Principle 1: Capital adequacy should be assessed on a group-wide basis.
In the assessment of capital adequacy on a group-wide basis, there are accounting/measurement
issues that need to be addressed. The situation where an insurance company owns shares in another
insurance company is fairly common. Creation of capital may occur, for example, where a parent issues
debt and down streams the funds to create equity in a subsidiary. In addition, less transparent or
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inappropriate means1 may be used to develop double gearing and internal creation of capital. This can
be performed through different channels using regulated or non-regulated entities. The assessment of
capital adequacy on a group-wide basis should adjust for forms of intra-group transactions, including
internal participation structures and intra-group transfers of capital and risks.
For the separate assessment of capital adequacy on a group-wide basis, a benchmark has to be
established against which that assessment is undertaken. That is, mechanisms exist to ensure capital is
adequate at the group level. It is acknowledged that in some jurisdictions, capital is calculated on a
solo entity basis only, with no separate group-wide capital requirement. However, in undertaking that
solo assessment due consideration is given to group impacts, including assessment of any insurance
holding companies.
The complexity of the task of assessing capital on a group-wide basis is largely dependent on the
complexity of the structure of the group itself. Some structural features or techniques which may raise
specific concerns include partially owned entities, cross-sectoral participations, a continuous sequence
of internal financing within the group, or closed loops in the financing scheme of the group.
To assess capital adequacy on a group-wide basis, three main approaches can be taken:

Aggregation methods: No capital requirement is calculated at group level on a consolidated basis.
Excess or deficits of capital existing at the level of each entity in the group, i.e. on a solo basis, are
aggregated (with relevant adjustments being made for internal holding) in order to measure
surplus (or deficit) at group level. Special care should be taken in the modeling of internal
transactions in order to make sure that the value and the risk of such instruments are consistently
treated across the whole group.

Consolidated methods: aim to calculate a capital requirement at group level treating the group as
a single entity, and determine whether this requirement is sufficiently covered by capital elements
at the group level. This category includes all methods of calculation that use group consolidated
accounts. This method will include all regulated entities in the group and any intermediate holding
companies. This method however has limitations in stress situations to the extent the group does
not behave or is not allowed to behave as one legal entity2.

Legal entity method: Calculate capital for the parent company only as a solo entity, with no
separate group capital requirements. However, group impact (at least risks and perhaps benefits)
are measured within the capital requirements. Additional group impact not measured within the
capital requirements is assessed in qualitative analyses. This method includes evaluation of
accounting/measurement issues and the economic and financial impact of any linked company
explicit and implicit relationships on the solo entity. This method also requires special attention to
the need to avoid unnecessary overlap and additional administrative burden through appropriate
communication and coordination among supervisors.
The choice of which method is appropriate would depend on the preconditions in a jurisdiction, the
legal environment, which assigns on what level the capital requirement is assessed, and the structure of
the group.
1
For instance ordinary loans may be granted to a non-regulated subsidiary which will downstream the proceeds in the form of equities in insurance
subsidiaries or other regulated financial entities within the group.
2
To address this problem, methods have been developed which focus on the structure of the group: the effects of intra-group transactions are
analysed and assessed by soundly modelling the capital flows between entities within the group, under adverse conditions, and assessing the
resulting financial risks and impacts on required capital of each entity and in particular the parent company.
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5.3 CEIOPS’s Advice for Level 2 Implementing Measures on Solvency II:
Assessment of Group Solvency (former CP 60)
This section summarises the recommendations of the CEIOPS‟ advice for the Level 2
Implementing measures that are relevant for the determination of the assessment of group
solvency. This advice is contained in “CEIOPS‟ Advice for Level 2 Implementing Measures on
Solvency II: Assessment of Group Solvency”3
a) Treatment of participations
The treatment of participations at group level should be based on the following criteria:

the classification and method of the participation should be based on economic
principles, not just on legal grounds. Control and influence should always be
assessed at a group level to determine the significance of participations. This
ensures that situations where several entities of a group have small participations in
the same undertaking are not overlooked.

in line with the principle above, the consolidation approach used for accounting
purposes should be used for solvency purposes to the extent they are based on
economic principles suitable for a solvency assessment.
Regulated financial entities with capital requirements should be included in the group
calculation using the deduction aggregation method when it is not appropriate to include them
through the consolidated method. This is to ensure there is no circumvention of the sectoral
rules. In principle, when assessing the aggregated group SCR, capital charges on intra-group
transactions should be eliminated. However, CEIOPS considers that further work may be
done at level 3 in order to avoid arbitrage and any unintended consequences from a
prudential point of view when applying the deduction and aggregation method.
When the group‟s participation in a (re)insurer is regarded as a dominant influence this will
imply a full integration of the participation in the accounts or a proportional integration (if there
is jointly shared control of the participation). In the case of a fully integrated participation,
minority interests would in turn contribute to cover part of the group SCR. The same treatment
applies to an SPV over which dominant influence is exercised.
3
CEIOPS-DOC-52/09 (October 2009)
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Where significant influence is exercised the contribution to the group SCR in respect of the
participation should be calculated as the group‟s share in the participation multiplied by the
solo SCR of this participation. This is consistent with the equity method consolidation where
such participations are accounted for at equity value in the group's consolidated accounts.
The contribution of these participations to the group SCR would be the sum of the abovementioned calculations.
For the group solvency calculation, the treatment of the other financial regulated entities
should be consistent with the Financial Conglomerate Directive (FCD). Related credit
institutions, investment firms and financial institutions shall, in accordance with the Financial
Conglomerates Directive, be included in the group calculation using sectoral requirements and
not allow for diversification.
In case of financial non-regulated undertakings a notional capital requirement shall be
calculated. Institutions for occupational retirement provision shall be included in the group
calculation using sectoral requirements and not allow for diversification.
Controlled insurance holding companies shall be consolidated, that is a full integration of the
participations in the intermediate insurance holding company and in the insurance
undertakings participated by the intermediate insurance holding company is required.
As a general principle, participations in entities outside the financial sector (both dominant and
significant influence) should be consolidated through the equity method. Treatment in the
group SCR should then be consistent with the treatment in the solo SCR.
Controlled ancillary entities should be consolidated through a full integration of the
participation in the accounts. Ancillary entities that are subject to a significant influence should
be consolidated through the equity method. Treatment in the group SCR should then be
consistent with the treatment in the solo SCR.
b) Method: Accounting consolidation
The accounting consolidation-based method provides for the calculation of group solvency
based on a set of consolidated accounts. The group solvency margin is the difference between
own funds eligible to cover the SCR and the group SCR calculated on the basis of
consolidated data (the consolidated group SCR).
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The group SCR calculated with the consolidated-accounting method is:
1.
the SCR calculated on the (re)insurance part of the group composed by all
(re)insurance undertakings for which diversification is recognised, named group
SCR;
2.
the sum of solo capital requirements SCRj calculated on each other regulated
undertaking j for which no diversification is recognized.
Article 221 provides for the treatment of proportional shares in related undertakings when
calculating the consolidated group SCR. The proportional share is the percentages used for
the establishment of the consolidated accounts. However, where a subsidiary is in deficit, the
total solvency deficit of the subsidiary shall be taken into account unless the group supervisor
is convinced that the parent undertaking‟s responsibility is strictly limited to that share of the
capital, whereby the deficit will be taken into account on a proportional basis. In making such
a decision, the group supervisor could consider the extent to which the parent undertaking
may be obliged to provide additional capital to the undertaking.
c) Method: Deduction & Aggregation
The deduction and aggregation method (alternative method) calculates the group solvency as
the difference between the sum of the aggregated own funds in the group and the aggregated
solvency capital requirements in the group. Diversification effects are already recognised in
solo calculations, but the deduction and aggregation method does not allow for additional
diversication effects at group level as the group SCR represents the sum of the solo SCRs.
Article 221 provides for the treatment of the proportional share in related undertakings when
calculating the aggregated group SCR. The proportional share is the proportion of the
subscribed capital that is held, directly or indirectly, by the parent undertaking. The approach
described for the treatment of solvency deficits described under the consolidation method also
applies for this method.
When calculating the aggregated group SCR the capital charge on intragroup transactions
should be eliminated in order to avoid charging two times the same risk. This will imply:

for internal reinsurance by eliminating the counterparty default charge on the
internal reinsurer (as long capital charge for the risks are considered in the
underwriting risk in the solo SCR of the internal reinsurer);
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
for participating undertakings to eliminate the capital charge on their participations
(as long as risks stemming from those entities are taken into account via the solo
SCR of those entities).
The SCR adjusted for those eliminations of double counting of intra-group transactions should
never be lower than the MCR of the considered (re)insurance undertaking as the floor to
group MCR only applies to the part of the group SCR calculated with the consolidatedaccounting method.
d) Choice of method
CEIOPS acknowledges that according to the Level 1 the accounting consolidation method is
the default method, for group solvency. However, the deduction and aggregation method can
be useful for dealing with specific group structures.
When making a decision pursuant to Article 220(2), the group supervisor, after consultation
with the other supervisors concerned and the group itself, shall assess, in particular:

the quality and access to information on an undertaking;

the impact of new entities falling within the scope of group supervision (i.e.
restructures, mergers and acquisitions);

entities that fall within the scope of a group internal model;

the level of complexity of the group calculation that would arise when requiring a
combination of methods and the impact on effective group supervision.
If a significant part of the group is still able to be consolidated based on the consolidation
method such a method should be used and the entities for which it is not appropriate should
be added by means of deduction and aggregation method.
e) Calculations
General
The group SCR is calibrated on the same basis as the SCR of a solo insurer – it aims to limit
the probability of ruin to 0.5% for all the parts of the group. The group capital requirement
equals the amount of economic capital needed in a group to meet all the quantifiable risks,
less the net impact of risk mitigation techniques, deriving from the business conducted by the
entities that form the group.
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Group specific risks
In order to reflect the total risks that the group may face, the group SCR should reflect the
risks that arise at the level of the group and that are specific to the group.
CEIOPS considers that group-specific risks should be addressed using the following
approach:

First, the group shall be required to calculate the group SCR either with the
standard formula or an internal model.

Second, supervisors shall acquire information on group-specific risks through,
among other means, the group supervisory review process (including the ORSA),
stress tests, scenario analysis or other quantitative or qualitative measures.

Third, if the group uses the standard formula and under the second step it has
become clear that there is a significant deviation from the assumptions underlying
the standard formula calculation (e.g. due to complex structures, etc.), the group
supervisor shall adopt the necessary measures to correct this situation. For this
purpose the group supervisor may require:
a. the use of an internal model pursuant to Article 119; or
b. the use of group specific parameters for underwriting modules where the
deviation arises from the application of those modules.

Alternatively, if the group uses an internal model, then the requirements of Articles
110 to 124 shall apply meaning that any deficiency due to group specific risks will
have to be addressed in the same way as for any other risks.

Finally, if the group is unable to fulfil the requirements above within an appropriate
timeframe, the group supervisor, in consultation with the supervisors concerned,
may decide as a last resort measure to impose a group capital add-on.
Reputation risk should be reflected in the group's Own Risk and Solvency Assessment. It is
essential that reputational risk is included in the business strategy and linked with the other
risk types. This includes defining functions and responsibilities, the available instruments and
the risk tolerance.
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Operational risk including legal risk is covered in a quantitative way in the SCR calculation. It
is not considered a group-specific risk. At group level the operational risk capital requirements
will be calculated in the same manner as at solo level.
Groups should deal with contagion risk within their Own Risk and Solvency Assessment.
Because of the difficulties associated with measuring contagion risk in a standardised way,
CEIOPS does not foresee the possibility to cover contagion risk explicitly in a quantitative way
on top of all the other risks in the standard model, though it may be possible for groups to
adequately capture contagion risk within an internal model.
It is the responsibility of the group to ensure that strategic risk is adequately managed not only
at solo level, but also at group level.
Although not reflected in the consolidated balance sheet, intra-group transactions risk should
be considered and are captured by Article 245.
A reinsurance arrangement entered into within a group should not result in a decrease in the
group SCR in the absence of financing external to the group when using the default method.
Group regulatory capital requirements are only permitted to be reduced therefore if the risk is
being transferred outside of the group. The analysis should include the impact of the default of
the main entity of the group responsible of external reinsurance, taking into account not only
the impact in the moment of default but also taking into account the necessity of a new
hedging.
Currency risk at group level needs to take into account the currency risk towards the currency
of the groups consolidated accounts. Therefore, the local currency referred to in the currency
risk calculation of the standard formula is the group currency for the calculation for the group
SCR.
f) Group SCR floor
Accounting consolidation method
For the purposes of the accounting consolidation-based method the Level 1 text defines the
group SCR floor as a minimum amount of group SCR under which the group SCR cannot
drop. This amount is defined in Article 230(2) as follows:
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“The consolidated group Solvency Capital Requirement shall have as a minimum the sum of
the following:
(a) the minimum capital requirement (Minimum Capital Requirement) as referred to in Article
129 of the participating insurance or reinsurance undertaking;
(b) the proportional share of the Minimum Capital Requirement of the related insurance and
reinsurance undertakings. That minimum shall be covered by eligible basic own funds as
determined in Article 98(4).
Given the nature of the accounting consolidation-based method, it is most likely that the group
SCR will be lower than the sum of SCRs of all insurance undertakings within the group due to
diversification effects. It is therefore necessary to ensure that the group SCR is at least above
the sum of all Minimum Capital Requirements.
Deduction & Aggregation method
When using the deduction and aggregation method for the group SCR calculation, it is clear
that the group SCR by nature of this method cannot be lower than the sum of solo SCRs as
no diversification is recognized.
Combination of the Consolidation and the Deduction & Aggregation method
The Level 1 text states that the group supervisor, after consultation with other competent
supervisory authorities concerned and the group itself, may allow the group to apply a
combination of the two prescribed methods for the group SCR calculation. In such case it is
not clear whether the group SCR floor should apply. However, to avoid double gearing
CEIOPS considers the group SCR floor should be applied when using the combination of both
admissible methods. In such case, the group SCR floor defined in Article 230(2) should only
apply to the part of the group covered by the consolidated method i.e. by comparing the sum
of the MCR of the entities covered by the consolidated method to the part of the group SCR
calculated with that method.
g) Group MCR
The solo MCR figure used for the group SCR floor calculation shall be the MCR determined
after applying the corridor referred to in Article 129(3) or after applying the absolute floor
referred to in Article 129(1)(d).
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h) Other
Assets
For the final measures the value of assets and other liabilities must be determined in
accordance with the requirements for solo insurers.
Technical Provisions
CEIOPS considers that the group best estimate of insurance liabilities should be the sum of
solo best estimate of insurance liabilities with only the elimination of the part of the best
estimate resulting from internally reinsured activities in order to avoid double counting of
commitments as in the consolidated accounts.
The group risk margin is a part of group technical provisions and should be equal to the sum
of solo risk margin in any case as it is already calculated net of reinsurance.
5.4 Pillar II Capital Add-On for group undertakings
CEIOPS‟‟ Advice for Level 2 Implementing Measures on Solvency II: Capital Add-On, details
the following principles for solo undertakings and for insurance groups („groups”) with regard
to Capital Add-Ons:
Principle 1 – Objective for setting a Capital Add-On
Setting a capital add-on is a supervisory power aimed at ensuring an adequate level of
Solvency Capital Requirement (SCR), thereby protecting policyholders‟ interests and
preserving a level playing field.
Capital add-on is a supervisory tool that allows supervisors to require undertakings to hold
capital in addition to the SCR as originally calculated by the standard formula or an internal
model, provided the supervisory review process leads to the conclusion that the level of
required solvency capital held by the company is insufficient or that the company needs to
remedy qualitative deficiencies.
CEIOPS has classified a capital add-on into two types:
Risk Profile Capital Add-on
Capital add-on triggered by a significant deviation from the risk profile embedded in the SCR
calculation, either calculated by the standard formula or by an internal model referred to as a
“Risk Profile Capital Add-On”.
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A Risk Profile Capital Add-On aims to ensure that the SCR corresponds to a confidence level
of 99.5% over a one-year period. Nevertheless, setting such a capital add-on is not a
substitute for either the development of an adequate (partial) internal model, the improvement
of an inadequate (partial) internal model or any other measure such as using undertaking
specific parameters.
Governance Capital Add-On
A Capital add-on triggered by a significant governance deficiency and referred to as a
“Governance Capital Add-On”.
A Governance Capital Add-On aims to protect policyholders‟ interests in situations where a
significant flaw in an undertaking‟s system of governance prevents it from being able to
properly identify, measure, monitor, manage or report its risks and where this cannot be
remedied within an appropriate timeframe. Setting a Governance Capital Add-On is a
measure taken to ensure that the SCR is high enough to cover the increased risks arising
from the significant governance deficiency.
Principle 2 – Due process for setting a Capital-Add On
The setting of a capital add-on should follow a due process. The supervisory authority should
give proper consideration to whether a capital add-on is an adequate supervisory measure,
taking into account the position of the undertaking concerned.
A due process for setting a capital add-on implies at least:

That all the relevant steps (such as the identification of an issue, the assessment of
the issue and then the calculation of an add-on if appropriate) have been followed;

That the results from the steps have been properly documented; and

That any relevant conclusion reached or measure taken by the supervisory authority
has been shared with the undertaking concerned, and that the undertaking has been
given the opportunity to present its views on these conclusions or measures including
providing additional information within an appropriate timeframe.
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Principle 3 - Identification
The implementing measures should be addressed by the undertaking taking into account the
principle of proportionality. Only significant risk profile or governance deviations are relevant
for the purpose of setting a capital add-on.
Principle 4 – Follow up
The setting and the amount of a capital add-on should be reviewed more frequently than
annually if there are indications that the situation that led to the setting of the capital add-on
has changed based on valid evidence.
Principle 5 – Communication with the undertaking
The disclosure made by the undertaking on the amount and justification of the capital add-on
should be compliant with the supervisory decision.
Group Capital Add-Ons
Principle 1 also applies at group level with the necessary adaptations. The objective of a
group capital add-on is the same as at solo capital add-on. That is, it is designed to be used in
exceptional circumstances to address deficiencies at group level.
Group-specific risks
One of the key issues in the Level 2 advice on group solvency is how to capture groupspecific risks in the group SCR. The quantitative impact study found that unique risks arise at
the level of the group (e.g. contagion risk or risks occurring at holding level) and that those
risks are generally not adequately captured by the standard formula. This is because the
standard formula is principally designed for a solo undertaking. It also found that internal
models were used to capture certain types of group-specific risk (e.g. restrictions on the
transferability of capital and reputation risk).
The assessment of group-specific risks is inherently complex as it is based on a collection of
related legal entities, not just the risk profile of a single legal entity, and the nature of groupspecific risks vary from group to group. Therefore, in order to understand the risk profile of the
group and the appropriate level of risk-based capital at group level, undertakings need to
understand the impact of the interrelationships between different entities and the correlations
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between different risk types. This may not be possible from the standard formula or the group
internal model.
Supervisors need to be able to assess whether this process has happened in an appropriate
manner. The difficulties implicit in reaching the decision of setting a capital add-on means that
supervisors will need flexibility in the process for applying a group capital add-on. Most groups
will be exposed to some degree of group-specific risks, but not all groups will be exposed to a
significant level of such risks that may necessitate a group capital add-on as a last resort
measure. This highlights the importance of assessing a group capital add-on on a case-bycase basis. The capital add-on process is part of the Pillar 2 supervisory review process as
described in CEIOPS‟ Level 2 advice on Group solvency assessment for the process of
assessing an add-on at group-level.
Impact of a solo capital add-on at group level
In Solvency II, article 232 requires supervisors to consider how a capital add-on at solo level
should be reflected at group level. However, article 233 refers only to risks that are difficult to
quantify (group-specific risks). This is because where the deduction and aggregation method
applies, any capital add-on applied at solo level would flow directly through into the
aggregated group SCR.
However, this raises the issue of how a capital add-on applied at solo level will be reflected
when applying the accounting-consolidated based method. The group SCR will be calculated
based on the consolidated accounts using either the standard formula or an internal model.
Then, the group supervisor, in cooperation with the College, will assess whether there is a
need for a capital add-on at group level. In doing that, add-ons existing at solo level will have
to be considered. It implies that the group supervisor will have to check whether the rationale
for the solo capital add-ons remains at group level. The degree to which a solo capital add-on
may be reflected in the group SCR may also depend on the size of the undertaking relative to
the rest of the group.
Process for setting a capital add-on in a group context
The principles on the process for applying a group capital add-on should be the same as at
solo level (i.e. it should follow the same stages and set of activities). However, in a group‟s
context, the process will need to take account of the use of group internal models, the
appropriateness of the standard formula and the regime for supervision of groups with
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centralized functions such as risk management. The process also needs to take account of
the coordination arrangements between supervisors facilitated by the college.
Where a group uses the standard formula to calculate its group SCR, the solo supervisor is
required to consult the college where it decides to apply a solo capital add-on. Where a group
internal model is used, the process for applying a solo capital add-on is provided for in Article
231(7) under Solvency II. Where Supervision of Group Solvency for groups with centralized
risk management applies, the solo supervisor must work through a process for determining a
solo capital add-on with the college. Therefore, the process for determining a solo capital addon where the undertaking is part of a group needs to take account of the group supervision
framework in place. This highlights the importance of the college arrangements in relation to
Articles 232 and 233.
Similarly at group level, the process for determining a group capital add-on will be guided by
the college arrangements. The coordination arrangements of the college are concluded by the
group supervisor and the other supervisory authorities concerned. The key point is that the
decision-making process for applying a group capital add-on and the consultation process for
applying a solo capital add-on is firmly embedded in the college arrangements.
Identification
Principle 3 also applies at group level with the necessary adaptations. This principle should
apply at group level. Where a group uses the standard formula, supervisors should consider
the benefits of modeling to account for significant deviations from the assumptions underlying
the standard formula. It is important to identify the sources of information on group-specific
risks in the group supervisory review process.
The identification of governance failures in a group are the same as for solo undertakings. In a
group context, the risk management and internal control systems and reporting procedures
must be implemented consistently in all undertakings in the group. Therefore, a poorly
integrated group system of governance could be an example of a governance deficiency and
a reason to apply a governance group capital add-on. For example, the head office may have
insufficient second-line review and challenge functions. Supervisors will need to take into
account what impact poor group governance has on the solo undertaking.
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Assessment
The limitation of the standard formula in capturing all risks is likely to be magnified at group
level. This highlights the potential benefits of modeling risks, particularly in capturing groupspecific risks. The complexity of groups and that they are more likely to change their structure
than solo entities (e.g. through selling subsidiaries, M&A activity, etc) will mean that the group
internal model may deviate from the group risk profile in the short term.
The key group issue with respect to the assessment of a governance failure is the
participation of supervisors in the college. The group supervisor will need to rely on the solo
supervisor‟s assessment of the implementation of the group system of governance. Similarly,
the group supervisor would be responsible for identifying governance failures within head
office. This should form part of the written arrangement of the college. As a general principle,
the timeframes for the imposition of a capital add-on need to be flexible at group level to
reflect the complexities of groups.
Calculation
CEIOPS is not convinced about the ability to formulate specific methodologies for calculating
capital add-ons as the calculation will depend on the nature of the circumstance that has led
to consideration about the capital add-on. CEIOPS considers this applies more so for groups
and so requires an even greater degree of flexibility. The calculation of a group governance
capital add-on should be assessed on a case-by-case basis to reflect the structure and
complexity of the group.
Follow-up
Principle 4 also applies at group level with the necessary adaptations. In a group context, this
will relate in particular to the assessment of group-specific risks. It is conceivable that the
reviews will be undertaken more frequently for groups to account for any dynamic change in
group specific risk (e.g. arising from changes in group structure). This may particularly be the
case where the group is in crisis.
Communication with the group and disclosure
Principle 5 also applies at group level with the necessary adaptations. This should be
consistent with the solo approach and included as part of the group Solvency and Financial
Condition Report.
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5.5 EU Quantitative Impact Study 5
a)
Calculation method
Groups were asked to test the methods envisaged in Solvency II to calculate their capital
requirements. In particular they were required:
1. To test both the accounting consolidation-based method and the deduction and
aggregation method (calculating it with both Solvency II and local rules for non-EEA
entities)
2. To provide data, if relevant, related to group solvency capital on the basis of a group
internal model.
3. To provide data, on an optional basis, on the application of a combination of the methods.
b) Main findings regarding group solvency assessment in QIS5
The main findings regarding group solvency assessment in QIS5 can be summarized as
follows:

Diversification effects varied considerably from one group to another and depended
strongly on the individual group structure. However, with an average diversification
effect of 21 percent, the effect appeared significant;

Diversification effects were greater for larger groups than for smaller groups;

Not enough groups reported data for group internal models to compare the group
SCR assessed with the standard formula and a “current” internal model.
5.6 Other relevant jurisdictions:
APRA
General
APRA has been developing a tiered approach to the supervision of general (non-life)
insurance groups, and in particular to the assessment of capital adequacy. This approach is
currently not proposed for life insurance groups as APRA requires amendment of its
legislative powers with regard to life insurance in order to implement group supervision in
that industry.
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The levels at which supervision would apply to non-life insurers are:
•
Level 1 - individual APRA-authorised general insurers (Level 1 insurers) on a stand-alone
basis;
o
Level 2 – consolidated general insurance groups (Level 2 insurance groups) that
incorporate all general insurers within the group, both domestic and international.
The group may be headed by an APRA-authorised insurer (Level 1 insurer) or an
APRA-authorised non-operating holding company (NOHC); and
o
Level 3 - conglomerate groups involving Australian insurers. This level would
encompass the entire conglomerate group headed by an APRA-regulated entity and
containing APRA-authorised institutions operating in more than one regulated industry.
This tiered approach is the same tiered approach as applies in banking supervision in
Australia.
Summary of Level 2 supervision
Ultimately, the objective of Level 2 general insurance group supervision is to ensure
that the group is financially sound and that group activities and inter-relationships do not
adversely affect the financial soundness of authorised Level 1 general insurers within the
group. This should reduce the risk of financial contagion across members of the group and
hence enhance the protection of Australian policyholders.
The foundation of APRA‟s approach to Level 2 supervision is that general insurance
Groups should meet essentially the same minimum capital requirement (MCR) on a
consolidated basis as apply to individual authorised general insurers. That is, there should
be no difference in MCR between a Level 2 insurance group with a number of subsidiaries
compared to a single insurer which operates with a number of branches.
It is not APRA‟s intention to require overseas subsidiaries of an Australian general insurance
group to meet Australian prudential standards on a stand-alone basis.
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In assessing the capital adequacy of the group:
•
The MCR of the Level 2 group would be determined using the prescribed approach or via
an internal model. Responsibility for capital management would rest with the Board of
directors of the parent entity.
•
The capital base would be assessed on a consolidated group basis. The effect of
intra-group transactions would be assessed at the group level. This may result in capital
instruments within entities of the general insurance group which are eligible as capital at Level
1 being excluded from the capital base of the group as a whole at Level 2.
•
Material subsidiaries operating in other industries, unrelated to the general insurance
business, would need to be deconsolidated from the Level 2 general insurance group and their
value would be deducted from the Level 2 group‟s capital base.
•
APRA would not prescribe where the surplus capital of the group can be held. Level 1
general insurers within the group would continue to be required to meet the MCR on an
individual (Level 1) basis.
APRA‟s prescribed approach to assessing the minimum capital requirement has three
components:
•
Insurance risk capital charge - relates to the risk that the value of net insurance liabilities is
greater than the value determined by the actuary at a 75% probability of sufficiency;
•
Investment risk capital charge - relates to the risk of an adverse movement in the value of
an insurer‟s on-balance sheet assets and certain off-balance sheet obligations;
•
Concentration risk capital charge - requires an insurer to hold capital against the highest
single loss expected to occur on a 1 in 250 year basis due to an aggregation of risks.
APRA‟s intention (under both the prescribed approach or where an internal model is used) is
to target an MCR with a 99.5% probability of sufficiency, based on a one year time horizon
with liabilities run-off to ultimate after that period.
Bermuda
General
The status of an insurance group‟s solvency position remains a key supervisory concern for
the Authority. As a solo supervisor, the Authority is keenly aware that Bermuda insurers are
affected by the financial position of the insurance group, especially where the Bermuda
insurers either supports or are supported by the parent. As Group-wide Supervisor, the
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Authority‟s remit will include ensuring that the insurance group‟s capital and solvency position
is adequate given the insurance group‟s overall risk profile.
The Authority explored a number of options to derive solvency for an insurance group. These
include:

The consolidation approach - which presumes that the insurance group is a single
economic unit and group solvency is determined using the group consolidated
financials as the base for either a standard model or an approved internal model. This
method also assumes that the assets supporting intra-group transactions within the
insurance group are both fungible and transferable.

The risk-based aggregation - approach which postulates that group solvency is
derived by summating the solo capital requirements and making relevant adjustments
to avoid double or multiple gearing of capital.

The legal entity approach - views the group as a “set of interdependent legal entities,
and not one single entity.”31 Capital requirement for each legal entity is computed,
taking into account intra-group exposures. These intra-group transactions are
modeled to derive the appropriate capital required to address these risks, and that
capital forms part of determining the overall group solvency requirement.
Group Capital Requirements
Insurance groups will be required to hold capital equal to the Group ECR. The Authority
proposes to use the consolidation method to calculate the insurance group‟s ECR
supplemented by elements of the legal entity approach where certain intra-group transactions
and investments in unregulated entities will be treated conservatively. Due to the recognition
of diversification effects in the consolidation method, the insurance group‟s ECR may be lower
than the sum total of the solo entities‟ regulatory capital requirements. The insurance group‟s
ECR should not, however, be lower than the sum of the solo entities‟ MSMs, which will serve
as the insurance group‟s ECR floor. The Authority proposes a MSM for the insurance group
by using the aggregation method to calculate the floor by which the insurance group‟s
regulatory capital should not be breached.
Where the aggregation method is used to determine the insurance group‟s MSM, the issue of
equivalence plays a key role. The aggregation method postulates that the solo entities‟
solvency requirements would be based on the solvency rules of the relevant jurisdictions. As
Group-wide Supervisor, the Authority would rely on the solvency calculations of the various
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jurisdictions, provided the Authority recognises them as equivalent. If a jurisdiction is not
recognised as being equivalent, the Authority will use its own solvency rules to assess the
solvency requirement of the legal entity.
Group BSCR
The Authority proposes to use the BSCR to determine regulatory group capital, although it
recognises that the BSCR framework may require some modification to make it applicable at
the insurance group level.
The Group BSCR Model will apply capital risk charges to assess the following risk areas:
a. Fixed Income Investment Risk
b. Equity Investment Risk
c. Interest Rate/Liquidity Risk (with a built in stress test)
d. Premium and Reserve Risks (general business and long-term business)
e Credit Risk
f. Catastrophe Risk (general business and long-term business)
g. Operational Risk
The Group BSCR Model will be calibrated at 99% Tail Value-at-Risk with a one year time
horizon. The model would provide for diversification along the lines of business written by the
insurance group as a whole.
Approved Group Internal Model
Insurance groups will have the ability to make application for their internal models to be
approved for the purposes of determining their regulatory capital requirement: similar to the
process that will exist under the solo solvency regime. The principles of the Internal Models
Standards will also be used to approve the insurance group‟s internal model.
5.7 Mapping of differences between above approaches (Level 2 and 3)
The IAIS principles describe group solvency assessments on a very high level. There is
however some important similarities when comparing to the CEIOPS framework. The detail
requirements set out in the Final Advice by CEIOPS reflects substantial similarities when
compared to the solvency jurisdictions of APRA and Bermuda.
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6. ASSESSMENT OF AVAILABLE APPROACHES GIVEN THE SOUTH AFRICAN
CONTEXT
6.1 Impact of the approaches on EU 3rd country equivalence
The assessment of group solvency does have an impact on EU 3rd country equivalence. In
early 2010, CEIOPS issued a consultation paper on the general criteria for equivalence. For
groups, this will include:

the equivalence of third country solvency regimes for the purposes of
Article 227;

the equivalence of third country prudential regimes for the purposes of
Article 260 (where the head of the group is outside the EEA).
The FSB will liaise with the EU as to attaining a 3rd country equivalence assessment once
substantial progress has been made in developing SAM.
6.2 Comparison of the approaches with the prevailing legislative framework
The interim measures for Insurance Group supervision will probably only be enacted during
2013. As stated earlier, this Discussion Document further evaluates the recommendations
made on the assessment of group solvency by the Insurance Group Task Group in the interim
measure on Insurance Groups (DD1).
7. RECOMMENDATIONS
The Task group recommends the following with regard to the assessment of Group
Solvency:
High level principles
High level principles relating to insurance group solvency requirements under
SAM:

The assessment of capital adequacy on a group-wide basis 4 should adjust for
forms of intra-group transactions, including internal participation structures
and intra-group transfers of capital and risks;
4
The assessment is only applicable to the entities falling within the scope of the group. Please refer to Discussion
Document 1 – Interim Measures for Insurance Groups
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
Should enable the supervisor to form a more soundly based judgment of the
group‟s financial situation;

No double use of own funds eligible for the group SCR.

It is possible to apply to use a group internal model for the purpose of
calculating the group SCR.
Choice of method
The task group proposes the following for purposes of SAM:

The DA method should be the default method under SAM;

However, groups should be allowed to use the AC method, but requires approval
by the Regulator,

A combination of the D&A and AC methods, which allows for diversification
between group entities included under the AC part.

It is furthermore proposed that allowance for diversification should only be
allowed for between South African insurance participations regulated under
SAM where the AC method is used, and not include group diversification benefits
for insurance participations in non- equivalent jurisdictions. The latter implies that
all insurance participations in non-equivalent jurisdictions should be included using
the DA method.
Deduction and Aggregation Method

The deduction and aggregation method calculates the group solvency as the
difference between the sum of the aggregated own funds in the group and the
aggregated solvency capital requirements in the group;
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Aggregated Group SCR

Group solvency equals
 eligible own funds of the parent and proportional share in related insurers;
 Less the value of the parent in related insurers (to ensure no double counting)
 Plus the SCR of the parent and proportional share of SCR of related insurers;

The solo SCRs need to be adjusted to avoid double charging of risks (market,
default, operational and underwriting risks) for intra-group transactions. Similarly,
the equity risk charge should also be removed within the solo SCR calculation for
insurance participations.

The group may take into account materiality considerations for purposes of the
adjustment for intra-group transactions. When calculating the aggregated group
SCR the capital charge on intragroup transactions should be eliminated in order to
avoid double counting risk charges. This will imply:
 for internal reinsurance by eliminating the counterparty default charge on the
internal reinsurer (as long capital charge for the risks are considered in the
underwriting risk in the solo SCR of the internal reinsurer);

for participating undertakings to eliminate the capital charge on their
participations (as long as risks stemming from those entities are taken into
account via the solo SCR of those entities).

After elimination for double counting intra-group transactions the adjusted solo SCR
should never be lower than the MCR of the considered (re)insurance undertaking
as the floor to group MCR;

Where an insurance subsidiary is in deficit (i.e. not enough eligible own funds to
cover SCR), the total solvency deficit of the subsidiary shall be taken into account
unless the group supervisor is convinced that the parent undertaking‟s
responsibility is strictly limited to that share of the capital, whereby the deficit will be
taken into account on a proportional basis. In making such a decision, the group
supervisor could consider the extent to which the parent undertaking may be
obliged to provide additional capital to the undertaking
Group SCR floor

When using the deduction and aggregation method for the group SCR calculation,
it is clear that by nature of this method, there is no group SCR floor. The group
SCR cannot be lower than the sum of solo SCRs as no diversification is
recognized.
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Alternative method: Accounting consolidation
Group SCR

Allowance for diversification under the AC method should only be allowed for
between South African insurance participations regulated under SAM;

Group solvency requirements are based on a consolidated balance sheet approach
recalculated using the standard formula or employing an internal model;

The balance sheet entities are consolidated according to the accounting
consolidation rules (with the impact of intra-group transactions and any internal
creation of capital being eliminated);

Balance sheet items should be valued as for solo insurers;

Assess the contribution of each undertaking to available group funds and allow for
diversification benefits;

The group SCR must > the aggregate of the full MCR of the parent and related
insurers;

The contribution of entities in non-equivalent jurisdictions to the group SCR floor
should be the local capital requirement corresponding to the final intervention point of
the local supervisor;

The minimum group SCR (group MCR) equals the sum of the solo level MCRs;

Diversification benefits are available within the calculation of group SCR between
South African insurance subsidiaries, regulated under SAM, within the group;

Diversification benefits should not be recognised in respect of other participations
(i.e. non-insurance participations and any insurance participations that represent
significant, as opposed to dominant, interest example 20% < holding percentage <
50%);

Where a subsidiary is in deficit, the total solvency deficit of the subsidiary shall be
taken into account unless the group supervisor is convinced that the parent
undertaking‟s responsibility is strictly limited to that share of the capital, whereby the
deficit will be taken into account on a proportional basis. In making such a decision,
the group supervisor could consider the extent to which the parent undertaking may
be obliged to provide additional capital to the undertaking;

The group SCR is calculated as the sum of the following components:
 SCR*: The SCR calculated in respect of the controlled insurance entities,
SPVs, insurance holding companies and ancillary entities;
 CROFS: The sum of the capital requirements of participations in other
financial sectors and IORPs assessed on the basis of sectoral rules without
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recognition of any diversification; and
 SCRNCP: The SCR calculated in respect of the non-controlled (significant
influence) participations in insurance entities, SPVs and ancillary services
undertakings without recognition of diversification benefits.
Group SCR floor

The group SCR floor is only relevant for the consolidation method;

The group SCR floor is equal to the sum of:
 MCR of participating (re) insurance undertaking; and proportional share of
the MCR of related insurance undertakings;
 For non-equivalent insurance entities and other financial sector entities, the
local capital requirement corresponding to the final intervention point should
be used.
Elements relating to both methods
Non-operating holding company

The work group proposes that Group solvency should only be required to be
calculated at the registered non-operating holding company (NOHC) level;

However, in order to calculate group solvency using the DA method, it will be
necessary to perform adjusted solo calculations similar to that used for solo insurers.
Solo assessments at NOHC level will not be required;

No group solvency calculations are required at „interim‟ group levels.
Treatment of participations
 Control and influence should always be assessed at a group level to determine the
significance of participations;
 Regulated financial entities with capital requirements should be included in the group
calculation using the deduction aggregation method;
 When assessing the aggregated group SCR, capital charges on intra-group
transactions should be eliminated;
 When the group‟s participation in a (re)insurer is regarded as a dominant influence this
will imply a full integration of the participation in the accounts or a proportional
integration (if there is jointly shared control of the participation);
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
Where significant influence is exercised the contribution to the group SCR in respect of
the participation should be calculated as the group‟s share in the participation multiplied
by the solo SCR of this participation;
 Related credit institutions, investment firms and financial institutions shall be included
in the group calculation using sectoral requirements and not allow for diversification;
 In case of financial non-regulated undertakings a notional capital requirement shall
be calculated.

Pension Funds shall be included in the group calculation using sectoral
requirements and not allow for diversification;
 As a general principle, participations in entities outside the financial sector (both
dominant and significant influence) should be consolidated through the equity
method. Treatment in the group SCR should then be consistent with the treatment in
the solo SCR.
 The recommendations highlighted below will focus on group solvency considerations
up to the ultimate holding company of an insurance group or insurance sub-group
that is also an FSB authorised NOHC; insurance groups or sub-groups falling under
the supervision of the BSD of the SARB are not considered. The recommendations
made will not apply to Category 1 or “Solo plus”5 (consisting of one insurer and one
or more non-financial entities) insurance groups.
Treatment of “non-equivalent” jurisdictions 6
 As Group-wide Supervisor, the Authority would rely on the solvency calculations of the
various jurisdictions, provided the Authority recognises them as equivalent. If a
jurisdiction is not recognised as being equivalent, the Authority will use its own
solvency rules to assess the solvency requirement of the legal entity;
 The following alternatives under the DA method for insurance subsidiaries in non equivalent jurisdictions are proposed:
o Include insurance subsidiaries at a nil value within group solvency provided there is
no deficit on the local solvency basis. This approach is feasible for example, where
the subsidiary is not material or relevant information is not available; or
o Include insurance subsidiaries using the local supervisory solvency rules (onl y DA
method); or
o Employ a PGN 104 statutory calculation methodology for insurance subsidiaries for
a transitional period (e.g. five years) such that :
5
For the definition of solo plus please refer to DD1 – Interim measures for Insurance groups.
Also refer to DD85 – Treatment of relevant insurance operations (in “non-equivalent” jurisdictions) , of SA parents
under the final measures to regulate the solvency of SA Insurance Groups
6
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 Group eligible own funds equal the proportional share of PGN 104 eligible
admissible assets;
 Group SCR equals CAR or a multiple of CAR (or, say, 1.2 times CAR). The
latter multiple is to allow for the fact that the CAR level is the final intervention
point under PGN 104; or
o Recalculate a SAM based SCR for insurance subsidiaries.
It is, however, worth noting that there are a couple of practical difficulties with last
approach:
Consistency of calculations between different subsidiaries relating to:
 The availability of an appropriate yield curve for the market to calculate technical
provisions (possible inconsistent treatment between insurers);
 Unlikely to have SCR stress calibration factors for each currency/economy
 What is „market consistent‟ in a country where the market is not deep and liquid,
and less sophisticated?
 Unduly onerous (financial and computational) requirements may cause certain
South African parents to decide that it is not commercially viable to maintain a
presence elsewhere in Africa which could place South African insurers at a
disadvantage in competing and expanding into the broader African market.
Assets

For the final measures the value of assets and other liabilities must be determined in
accordance with the requirements for solo insurers except for participations.
Group Technical Provisions

The group best estimate of insurance liabilities should be the sum of solo best estimate
of insurance liabilities with only the elimination of the part of the best estimate resulting
from internally reinsured activities in order to avoid double counting of commitments as
in the consolidated accounts. The group risk margin is a part of group technical
provisions and should be equal to the sum of solo risk margin in any case as it is already
calculated net of reinsurance.
Capital add-on
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
In general, a capital add-on group SCR may be imposed by the FSB where it
considers that the risk profile of the group is not adequately reflected by the group
SCR;

Capital add-on is a supervisory tool that allows supervisors to require undertakings to
hold capital in addition to the SCR as originally calculated by the stan dard formula or
an internal model;

The principles on the process for applying a group capital add-on should be the same
as at solo level;

Where Supervision of Group Solvency for groups with centralized risk management
applies, the solo supervisor must work through a process for determining a solo
capital add-on with the supervisory college7. Therefore, the process for determining a
solo capital add-on where the undertaking is part of a group needs to take account of
the group supervision framework in place;

The group supervisor will need to rely on the solo supervisor‟s assessment of the
implementation of the group system of governance. Similarly, the group supervisor
would be responsible for identifying governance failures within head office. This
should form part of the written arrangement of the college. As a general principle, the
timeframes for the imposition of a capital add-on need to be flexible at group level to
reflect the complexities of groups;

The determination of a group governance capital add-on should be assessed on a
case-by-case basis to reflect the structure and complexity of the group;

Two types of add-on

Risk Profile Capital Add-on
o
Capital add-on triggered by a significant deviation from the risk profile
embedded in the SCR calculation, either calculated by the standard formula
or by an internal model referred to as a “Risk Profile Capital Add-On”.
o
A Risk Profile Capital Add-On aims to ensure that the SCR corresponds to a
confidence level of 99.5% over a one-year period. Nevertheless, setting
such a capital add-on is not a substitute for either the development of an
adequate (partial) internal model, the improvement of an inadequate (partial)
internal model or any other measure such as using undertaking specific
parameters.

Governance Capital Add-On
o
7
A Capital add-on triggered by a significant governance deficiency and
Supervisory college should be read together with Discussion Document 1 – Interim Measures for Insurance Groups
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referred to as a “Governance Capital Add-On”.
o
A Governance Capital Add-On aims to protect policyholders‟ interests in
situations where a significant flaw in an undertaking‟s system of governance
prevents it from being able to properly identify, measure, monitor, manage
or report its risks and where this cannot be remedied within an appropriate
timeframe. Setting a Governance Capital Add-On is a measure taken to
ensure that the SCR is high enough to cover the increased risks arising from
the significant governance deficiency.

A due process for setting a capital add-on implies at least:

That all the relevant steps (such as the identification of an issue, the assessment
of the issue and then the calculation of an add-on if appropriate) have
been followed;

That the results from the steps have been properly documented; and

That any relevant conclusion reached or measure taken by the supervisory
authority has been shared with the undertaking concerned, and that the
undertaking has been given the opportunity to present its views on these
conclusions or measures including providing additional information within an
appropriate timeframe;

The implementing measures should be addressed by the undertaking taking into
account the principle of proportionality. Only significant risk profile or
governance deviations are relevant for the purpose of setting a capital add -on;

The setting and the amount of a capital add-on should be reviewed more
frequently than annually if there are indications that the situation that led to the
setting of the capital add-on has changed based on valid evidence;

The disclosure made by the undertaking on the amount and justification of the
capital add-on should be compliant with the supervisory decision;

The objective of a group capital add-on is the same as at solo capital add-on.
That is, it is designed to be used in exceptional circumstances to address
deficiencies at group level.

The following proposed requirements proposed for group level capital add -ons
specifically:

If the DA method applies, solo level capital add-ons flow directly into the group
solvency calculation;

If the AC method applies – solo level capital add-ons need to be considered as
they do not flow into group level SCR automatically. The FSB needs to assess
whether the reason for the solo level capital add-on remains at group level and
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the relative size of the insurer to which the solo level capital add-on applies; and

A group with a poorly integrated governance system might qualify for a group
capital add-on. However, the calculation of a group governance capital add-on is
likely to be complex and should be assessed on a case-by-case basis;

At the same time the work group recommends that the process of imposing a
capital add-on requirement to a group‟s SCR should be done on a case-by-case
basis according to a robust process to ensure transparency and avoid potentially
adverse consequences. For example, if the regulator decides to impose a
Capital add-on requirement after the release of year end results. Restatement
of group solvency to reflect the capital add-on; may impact publicly disclosed
financial statements which may have to be restated and could even result in a
requirement to republish year end results.

The task group suggests that an approach similar to the individual capital
guidance provided by the FSA in the UK could be considered i.e. capital add -on
guidance provided to the group that applies to the following reporting period;

It is also suggested that the regulator should also consider the effect of their
actions in connection to pro-cyclicality, particularly when the financial market is
facing extreme movements;

Furthermore, a consultation process for applying a capital add-on should be
embedded in the college arrangements.
Approved Group Internal Model

Insurers belonging to a group should be able to apply for the approval of an internal
model to be used for the solvency calculation at both group and individual levels;

Insurance groups will have the ability to make application for their internal models
to be approved for the purposes of determining their regulatory capital requirement:
similar to the process that will exist under the solo solvency regime. The principles
of the Internal Models Standards will also be used to approve the insurance
group‟s internal model;

The group Solvency Capital Requirement shall reflect the risks that arise at the
level of the group and that are specific to the group;

When a group internal model is used to assess the solo SCR of related
undertakings, the provisions defined at solo level shall apply. The calculation shall
not take into account any group diversification, either directly or indirectly.

Groups shall demonstrate that the system for measuring diversification effects
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realised at group level is adequate and fulfills the requirements for solo internal
model. As there may be some risks which specifically arise as a consequence of
the group activity and which are to be quantified, groups shall take any reduction in
diversification benefits due to these risks into account;

Undertakings shall analyse the results, review the interaction of risks and mitigating
actions, make recommendations and revise scenarios and calibrations in the light
of the results. The results shall be reviewed both at local as well as at a group
level;

For group internal models, consideration will need to be given to the interaction
between the related risks in different subsidiaries;

For group internal models, adaptations may be necessary to capture the specific
risk profile of individual portfolios. However, data and parameter settings used in
the internal model shall be consistent throughout the group.
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