Solvency II and return
on equity; optimizing
capital and manage
the riskMaria Haug Edvardsen
GRC 2016, May 19
Content
• Solvency II introduction
• return on equity
• risk appetite and risk
tolerance
• framework on risk
management
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Solvency II - the basics
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Solvency II
Purpose:
• to reduce the risk that an insurer would be unable to meet
claims;
• to reduce the losses suffered by policyholders in the event that a
firm is unable to meet all claims fully;
• to provide early warning to supervisors so that they can
intervene promptly if capital falls below the required level; and
• to promote confidence in the financial stability of the insurance
sector.
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Solvency II
Pillar I
quantitative
capital
requirements
Pillar II
qualitative
requirements
Pillar III
reporting and
disclosing
«To have enough
resources when
something bad
happens»
«To prevent
something bad to
happen»
«To say what I
have, what I need
and what I do»
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Solvency II – pillar I
Assets at
market
value
Solvens Capital Requirement (SCR)
Technical Provisions
Best estimate
Risk margin for non-hedgeable risks
Assets covering technical
provisions, MCR and SCR
Minimum Capital Requirement (MCR)
BufferNew Solvency II
balance
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Pillar II
• governance
• fit and proper
• risk management
• ORSA
• internal controls
• internal audit
• actuarial function
• outsourcing
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Pillar III
Disclosure and transparency:
• SFCR (solvency and financial
condition report)
• RSR (regular supervisor report)
• QRT’s (quantitative reporting
templates)
• ORSA (own risk and Solvency
assessment)
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Return on equity
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Return on equity
• Traditional financial theory assumes that the higher the risk you
are willing to take, the higher the potential return (and potential
losses) can be expected.
• Running a company involves in itself a certain risk.
• A company must take risks to achieve a return on capital.
• Return on equity (ROE) measures the return on the capital that
the owners have put into the company, and can show how
profitable a company is for its shareholders.
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Return on equity
• The new risk-based Solvency II regime requires companies to, at
a much greater extent than previously, link the company's capital
to the actual risk they face at a selected strategy.
• The capital base consists of: risk capital and buffer capital.
• Risk capital is the amount of capital to cover the risks the
company faces. Other capital will be considered as buffer capital.
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Risk appetite and risk tolerance
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Risk appetite
• One of the boards’ responsibility
is to define a clear strategy for
the company and a risk appetite
• How to establish a proper risk
appetite?
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Risk appetite and risk tolerance
Risk universe
Risk capacity
Risk tolerance
Risk appetite
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Risk Appetite
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Risk too low
Risk Appetite
Risk too high
Target
Limit
Tolerance
Risk Capacity
Risk appetite – how to define it?
Source: Institute of International Finance: ”Implementing robust risk appetite frameworks
to strengthen financial institutions”, 2011
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Risk appetite - input
Strategy and risk
• rating
• growth
• efficiency
• solvency ratio target, minimum ratio target
• results
• RoE
• growth
• VaR Limits
• minimum level for business continuity
• etcetera
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Examples
high growth ambitions
high risk appetite
high risk tolerance
high targets on rate of return
low risk appetite
high risk tolerance
How much capital do a company need in order to reach its
strategic targets?
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Risk Capital
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Risk capital and
buffer capital
• How to decide the right amount
of risk capital (the right risk) and
an adequate capital buffer? (Too
much capital buffers could
impose excessive costs on both
the costumers and the sector).
• The boards responsibility:
strategy, risk appetite.
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Return on equity and buffer capital
Assets at
market
value
Solvency Capital Requirement (SCR)
Technical Provisions
Best estimate
Risk margin for non-hedgeable risks
Assets covering technical
provisions, MCR and SCR
Minimum Capital Requirement (MCR)
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Optimize the capital
MCR
SCR
ORSA
Pilar I Pilar II
SCR
internal
model
add-on
from
FSA
add-on to
please
rating
agents,
etcetera
actual
capital
?
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Solvencymargin (%) = Available capital/SCR
Minimum 100 %
Risk capital
ZoneSolvencymargin
(examples)
red < 120%
yellow 120-160%
green 160-200%
yellow >200%
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Distribution of risk capital
45
30
1015Example:
Risk appetite pr.
category or
products
Goal:
to optimize the
allocation of
capital
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Risk management
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Riskunivers & risk capital
Strategic
risks
Insurance
risks
Financial
risks
Operational
risksOther risks
Aggregated
riskRisk capital
Policies and mandates
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Risk management framework
Risk appetite and risk tolerance
Governance, organization and people
Strategy and policyInternal controls and assurance
Risk identification, transfer, mitigation and reporting
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Risk function
• aggregated view on risk (today and forward)
• integrated part of the business processes
• ORSA
• risk reporting
• fit and proper
• capacity
• authority
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Compliance function and internal
controls
• help the company to not exceed the risk limits and not breach
regulatory requirements
• appropriate internal controls: quality, efficiency
• independent reporting line to the board
• fit and proper
• capacity
• authority
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To sum up
• Is there a connection between
the desired returns, established
capital, actually risk-taking and an
adequate risk management
program?
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Questions?
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Maria Haug Edvardsen
• Partner & Head of department
• Transcendent Group Norway
• +47 992 711 80
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www.transcendentgroup.com