To each insurer its own capital calculation formula and budget
Insurers, which have until 2013 to implement either an internal model or the standard formula, are busy exploring their options.
arge as well as smaller players will have to comply. Insurance companies, mutual societies, provident organisations, reinsurers... have until 31 December 2012 to prepare themselves and ensure that they have sufficient capital to cover their risks.
Moreover, with this goal in mind, they will have to opt for an SCR (Solvency Capital Requirement) calculation method at a cost of millions of euros. A method either based on a standard formula or by implementing a full internal model, based on their specific risk structure, or alternatively for a kind of two-in-one, a partial internal model which is a mixture of the standard formula and an internal model, depending on the company’s business lines and risks.
After having examined the proposed regulatory change and followed the quantitative impact studies for three years, Vauban Humanis will limit itself to a standard formula. "It requires substantial resources to develop an internal model and it is an extremely expensive procedure, notes Didier Bonneau, the social protection group CFO. The issue for us is the balance sheet cost." Within the Solvency II environment, insurers and mutual societies now have to adopt an economic approach based on their risks as a whole (financial, operational, etc.). And because the directive stipulates that liabilities should be valued at their market value, "when financial market fall by 30 %, that can cost 50 basis points in solvency capital depending on the structure of the asset portfolio, explain the CFO.We therefore need to adjust our liabilities and assets in order to control the volatility of liabilities." The priority objectives for Vauban Humanis will be, in decreasing order, to control the volatility of the balance sheet cost, to maintain the level of financial income of the institutions and finally the SCR.
Other specificities, another size and another project: "We have opted for a partial internal model, emphasises David Simon, Director of Risks at the AG2R La Mondiale Group. The idea is to use the standard model for lower risk activities but to opt for a customised solution for the specific risk characteristics of our core activity." The hybrid approach authorises an "enriched" standard formula; a particularly interesting approach for small and medium-sized companies which do not have the means to develop a full model for their activity. "Given the limited scale of our casualty insurance activities, we are not going to add specific parameters to the basic model", he adds. On the other hand, like many insurance companies, inflation risk is covered by physical real estate holdings. "As regards the direct management of real estate risks, the standard formula does not recognise the ‘rate’ component of this asset(sensitivity of rents to interest rate changes, editor’s note)and imposes a solvency capital of 25 % on the one hand and an indirect penalty for the increase in the interest risk rate which is far too high in our opinion." Another example, the health risk. The regulatory scale has been determined on the basis of European statistics, from the first euro. "As a French insurer, our operational reality is different and moreover our role is to supplement the basic scheme", explains David Simon.
Alongside these medium-sized companies, the insurance heavyweights are applying themselves to putting in place a single internal model, for which they have already a competitive advantage. A number of large institutions already have "their own internal asset/liability projection models and need to transform them into a certified single model, compatible with the Solvency II regulatory standards. But the challenge is undoubtedly difficult given the calendar", adds David Simon. For its part Axa France plans to integrate both solutions: the standard formula and the full internal model. The group’s lead companies, Axa France Vie, Axa France IARD and Axa Corporate Solutions are opting for the second solution. "Despite a tight schedule, we are relying on our own internal model, explains Sabine Leboulanger, Head of the Solvency II Programme at Axa France. The other smaller entities, such as Axa Assistance, will adopt the standard formula. This principle of proportionality will also be applied to foreign subsidiaries."
On the other hand, at Generali, all the transalpine insurer’s subsidiaries will opt for a full internal model. "We are preparing for the approval of our model by the regulatory authority", explains Hélène N’diaye, Risk Management Manager atGenerali France. A decisive stage, as the directive stipulates that the supervisory authority will be entitled to require additional capital if it considers that the company’s demands are too ambitious. Customised solutions are validated very closely and regularly. "Insurers will have to demonstrate that their capital requirements based on their internal model are adequate… every year", she adds. The implementation of the European regulation seems to require considerable efforts on the part of insurers. "In addition, the key for the data input of these internal models is not so much the modelling and aggregation of all the risks, but rather the quality and depth of the data, emphasises David Simon. That is why we are investing in processes to improve the quality of these data, as our systems must produce reliable data." Thus, at AG2R La Mondiale, a ten-people team has been working for the past three years on a programme for the automation and production of these data. Without being a specific condition imposed by Solvency II, this approach is inherent in the directive’s requirements. But at the end of the day, these efforts are likely to bear fruit. The capital requirements of insurers having opted for the standard approach are likely to be higher than those of companies which favour an internal model. "Because of the crisis, capital requirements are high, emphasises Sabine Leboulanger. Although the internal model approach is more resource consuming, it is also the only approach which makes it possible to control more closely the risks inherent in the company’s activities." The crux of the matter for these companies will be to reduce as far as possible the amount of capital required.