Thursday, 26 May 2011

Solvency II and Proportionality

For my own benefit I am posting my notes on the proportionality guidance issued by CEIOPS back in 2008 - feel free to use as you wish!

In particular, if the Internal Model levies are likely to be proportional to the nature scale and complexity of the undertaking, it is important to be able to argue the toss if one feels one is being overcharged!


Level 1 – proportionality established as general principle, leaving details to L2

Article 28  - proportionality linked to “nature scale and complexity of the risks inherent in the business”

Nature criteria
  •  Classes of business (short/long tail)
  • Low frequency/high severity or vice versa
  • Reinsurance/captives get bespoke treatment
Scale criteria
  • Size criterion (assets. liabilities or risks)
  • Governance processes via scale and cost benefit analysis
  • Cash flows of investments not interest-rate sensitive
  • Homogeneity of portfolio
  • Similar characteristics of policies mean valued using model points
  • Product lines with increasing complexity (Life business with/without options and guarantees, Non-Life with/without renewal options)
Applies to all provisions, and therefore by proxy, all future implementing measures

Applies to both implementation of directive and conduct of supervision

“The individual risk profile should be the primary guide in assessing the need to apply the proportionality principle”

Pillar 1
“Justifies simpler and less burdensome requirements for low risk portfolios”

“In order to be considered proportionate a measure has to be, at least, suitable and necessary to achieve its objective as well as appropriate”

“Lack of resources can never be an excuse for not complying with supervisory standards”

Pillar 2
“function” denotes that a person/s must perform the task, not that they are precluded from doing other tasks.

“high risk undertakings may also be expected to introduce a code of conduct” – this followed by a piece on “complex risk profile” undertakings needing expertise in ‘the development of an internal model’. Not sure if the implication is high/complex risk means all internal model applicants.

“Insurers risk management function should be closely integrated with its capital management function, and its risk management policy should describe how this interaction takes place” very important!

“there will be very limited scope for proportionality with regard to the quantity and quality of its regulatory capital requirements”

“One aim of documentation is helping communication between the board of directors, management and personnel. The description should be intelligible and comprehensible also to a knowledgeable third party.” – benchmark for policy writing

“Not only can the compliance function be outsourced but it may also be performed by members of the management or administrative body”

Pillar 3
“CEIOPS places particular importance on the proportionality principle where supervisory reporting is concerned”

“CEIOPS believes that public disclosure as a principle is required in order to enhance market discipline and thus must apply to all undertakings”

Internal Model
“Proportionality should never be put forward to justify a failure of the use test, not meeting the statistical quality standards or not properly validating the internal model and its use.”

“Proper segregation of duties, as appropriate given the nature complexity and scale of the business, can be viewed as a mitigating factor” – for key person risk on Internal Model

“As regards the validation function, CEIOPS does not consider that each company must have this task fulfilled by independent staff” – followed with “it is also essential that the individuals performing the validation possess the necessary up to date skills, knowledge, expertise and experience”

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