Solvency II survey 2011 insurers responses to evolving rules

Having been immersed in preparations for the Solvency II regime for several years now, insurers are faced with the continuing challenge of responding to a mandatory change where the exac

Solvency II Survey 2011

Insurers’ responses to evolving rules

We are delighted to present this fourth annual

Deloitte Solvency II Survey Having been

immersed in preparations for the Solvency II

regime for several years now, insurers are faced

with the continuing challenge of responding

to a mandatory change where the exact ‘rules

of the game’ are still evolving

This report has been produced on our behalf by the Economist Intelligence Unit based

on their findings from interviews during February 2011 with 60 insurers with UK

operations Through their fully anonymous survey process, the Economist Intelligence

Unit is able to offer an impartial view of the true state of play for UK insurers and also

give a flavour of the trends since the last survey

Survey information can provide organisations a useful checkpoint as preparations

continue and offer a perspective on where they stand in relation to their peers

Significant progress has been made over the last 12 months and the survey identifies

some interesting developments and trends

The report’s findings highlight the far reaching consequences of Solvency II, including

the number of companies looking at restructuring or relocating and the anticipated

consumer impact as a result of changes in product mix, design and pricing

Implementation resource shortfall across the industry is a significant challenge and

there is a decline in confidence that the industry will complete the journey on time

We are very grateful to the EIU and to all participants for their contribution to this

research I hope you find the Solvency II Survey 2011 useful – please do contact me if

you would like to discuss any aspect of this report

Rick Lester

Solvency II Lead Partner

rlester@deloitte.co.uk

The European insurance industry has been immersed in preparations for the Solvency II regime ever since the adoption of the final text of the Directive in 2009

Yet much preparatory work remains to be done as organisations, along with their local regulators, continue to wait for the regulatory requirements for implementation to be finalised While the final deadline for compliance is moving from November 2012 to

1 January 2013 there is uncertainty as to how the transitional arrangements will be applied in practice

The European Insurance and Occupational Pensions Committee (EIOPC) and the European Commission are currently scrutinising level two implementing measures (which will specify how the Directive’s principles must

be applied in practice) The outcome of this is dependent upon the EIOPC’s simultaneous review of the Omnibus

II Directive to bring Solvency II into line with the Lisbon treaty, which will come into force in the fourth quarter

of 2011 The European Insurance and Occupational Pensions Authority (EIOPA) will also be developing level three text until the end of this year and will approve the final guidelines after a period of consultation in the first quarter of 2012

In February this year, the chief executive of the Financial Services Authority (FSA), Hector Sants, acknowledged a number of outstanding issues of the “utmost

importance” to the insurance industry regarding Solvency II and noted that further debate and analysis were still needed to address ongoing anxieties However, as the window of opportunity to shape the final regulations gradually closes and insurers are expected to work within the new regime, how ready is the industry for implementation and what are the causes of greatest concern?

Following on from research in 2010, the Economist Intelligence Unit, commissioned by Deloitte, again surveyed a sample of 60 UK-based insurers to ascertain their latest views on Solvency II and reassess their readiness for the new regime Respondents covered all types of business from smaller, stand-alone

organisations to large groups

Respondents were grouped by size with the very largest insurers reporting more than £5bn in net written premiums (NWP); large insurers with between £1bn and

£5bn NWP; those with £500m to £1bn; £300m to

£500m; £100m to £300m; and less than £100m NWP Thirty respondents were life companies, 28 were non-life and two were composite

Introduction

Figure 1 In which region is your head office domiciled?

86%

5% 4%

5%

UK Australasia Other Europe North America

Figure 2 Where does your group operate?

%

0 10 20 30 40 50 60 70 80

Asia Latin America Middle East/

Africa

North America Other

Europe UK

Ninety-five percent of respondents’ boards were fully

aware of and engaged in the regulatory responsibilities

and opportunities arising from Solvency II, a rise from

83% in last year’s survey Only the very smallest insurers

were yet to brief their boards on the potential

implications of the new regime, while one non-life

insurer with between £100m and £300m admitted that

its board had no knowledge of Solvency II at all

This lack of awareness was atypical, however, with

most insurers taking positive action in preparation for

the regime Ninety percent of all respondents and

100% of insurers with over £500m NWP had

completed a gap analysis, while two-thirds of those

surveyed had made the business case for Solvency II

Ulrich Zink, policy adviser at the Association of British

Insurers (ABI), says: “Solvency II is clearly a top priority

for the boards of insurers in the UK Whether this

awareness is being driven by the regulator or internally,

you can be certain every board in the UK is aware of

Solvency II and is acting on it.”

More than half (52%) of all respondents had reached

the implementation stage including 75% of the very

largest insurers (with over £5bn NWP) Reflecting this

level of advancement, 60% of respondents have at least

60% of their complement of full time Solvency II

employees already embedded However, the remaining

40% have 40% or less of their dedicated Solvency II

personnel in place, with as many as seven (12%)

insurers having only embedded 20% Training

programmes are scheduled at 58 of the 60 insurers

surveyed, with half of the respondents offering general

training for all employees and tailored training for key

personnel

Heightened awareness

Figure 3 What approximate percentage of the FTE resource required for your Solvency II programme has been put in place?

%

0 5 10 15 20 25 30 35 40

100% 80%

60%

40%

20%

0%

Figure 4 What training programme do you have in place for Solvency II?

%

0 10 20 30 40 50

Tailored training for all impacted

by Solvency II

No structured programme General

training for some

General training for all Tailored

training for some

A combination

of general training for all and tailored training for some

In spite of the ongoing uncertainty over the final demands from Solvency II, insurers are pressing ahead with their preparations for the new regime The focus

of attention remains the same as last year and relates

to preparations for securing approval for new internal models Given that 80% of respondents plan to implement a full internal (50%) or partial internal (30%) model under Solvency II, issues such as data infrastructure and data handling were listed as top-five priorities for the next six months, particularly among large insurers Similarly, implementing risk governance also tops the agenda for the first half of 2011 While the EIOPA is yet to publish guidance on internal models, which will be laid out in the commission’s level-two measures expected in June this year and EIOPA’s level-three requirements due in December, insurers were still focusing on internal model design and implementation, as well as the internal model approval process (IMAP) itself

Respondents to the survey were confident they would meet the deadlines in this area with most insurers (88%) expecting to have entered the IMAP by the fourth quarter of 2011, one in 10 by the first quarter

of 2012, while just one insurer (with NWP greater than

£1bn) admitted it would be later

In last year’s survey, one-third of respondents said they would lobby the regulator and industry bodies for support in dealing with the IMAP Subsequently the ABI has produced guidance for insurers, endorsed by the FSA The document, released in February, suggested large insurers have their work plan in place by the end

of March this year in order to reduce the burden on both their own organisation and that of the regulator in the run-up to final implementation of Solvency II

Future focus

Figure 5 Which of the following areas will your organisation be focusing on most in the

next six months? (Respondents were asked to select and rank five)

Deloitte comment – Richard Hurley

Technology implementation issues are now becoming real The designs that

have been developed are being handed over to the IT development teams

and delivery plans are being developed These plans are now showing that

either timescales are going to have to move or scope is going to have to be

reduced

In addition, although in many cases the architectures are simple, applications

are being pushed beyond their original design specifications, either from

a functionality or performance point of view This complexity is being added

to by the need to undertake complex integrations with legacy systems

For these reasons, many insurers are looking at how they can implement in

a phased way and/or looking at using prototypes during the first phase of

their implementations

Data remains a key area of concern, be it the accessibility or granularity of

data, and in many cases its quality Therefore many organisations are now

looking at how they can simplify their data requirements in order to achieve

a realistic solution

Finally, the scale of the testing requirement is coming into focus The overall

approaches to system integration and user acceptance testing are being

developed These critical activities are putting pressure on overall timescales

Understandably, respondents to the survey recognise

that implementing such a regulatory overhaul will have

far-reaching implications for their businesses Nearly half

(47%) will have to reorganise or restructure as a result

of Solvency II, with the highest instances among life

insurers with between £1bn and £5bn NWP (71%)

Much of the restructuring will arise from insurers

recognising more efficient means of managing capital

via branch rather than subsidiary structures

While there may be opportunities to take elements of

the business outside of the EU, relocation remains

unlikely for most insurers, with just 8% of respondents

saying they would move their business headquarters,

as the tax implications of moving to new territories may

preclude any benefits from side-stepping Solvency II

However, one of the four largest insurers responding to

the survey is considering relocating

Life insurers were more likely than their non-life counterparts to make changes to their product mix,

as capital requirements under Solvency II have a much greater impact on the types of long-term guaranteed products offered by life companies One in five life insurers said they envisage changing their product mix and redesigning products, compared with fewer than one in 10 non-life companies, while one-third of life companies and one in 10 non-life companies identified opportunities to launch new products under the new regime

Mr Zink says: “Life insurers are selling long-term guarantee products and those attract heavy charges [under Solvency II] These are crucial products as many people rely on them for their retirement If the requirements remain as they currently are, firms will have no option but to either significantly increase premiums or to reduce their offering, shifting towards products where the risk remains with the policyholder

Both scenarios will be to the detriment of the consumer for whom it is important to have good access to a range of appropriate products and propositions.”

Given that a key motivation for introducing Solvency II is better appreciation and management of risk within the European insurance industry, it comes as no surprise that two-thirds of all respondents will introduce new risk-mitigation techniques While an equal number of life and non-life companies said they would take this step, neither

of the composite respondents had plans to do so

Repercussions

Figure 6 As a result of Solvency II, do you envisage your

organisation will need to do any of the below?

%

0

10

20

30

40

50

Not decided Relocation

Reorganisation/

Restructuring

Deloitte comment – Stephen Ross

As the implementation date for Solvency II approaches and board level awareness of its impact increases, it is apparent that insurers are beginning

to appreciate the real implications it will have for their business It is very clear from the Survey and from our client conversations that Solvency II is acting as a catalyst for businesses to restructure For many businesses the driver for this has been to maximise capital fungibility and thus to be able

to allocate capital effectively across the group This means that many businesses are transitioning from subsidiary structures (where capital is trapped in individual entities) into ones with branch structures where capital

is more fungible across the group

Another possible implication of Solvency II is the potential for M&A We expect that as the financial metrics associated with Solvency II become clearer, insurers will consider the options to drive towards the ideal business mix whilst being aligned to their overall strategy This is likely to lead to M&A activity in the form of acquisitions or disposals of portfolios, teams or companies as businesses look to achieve the scale and diversity they see as optimal under the new regime

As the transparency requirements of Solvency II make it

easier for insurers to identify which product lines are

most profitable and which are most capital-intensive,

businesses will be well-placed to streamline their

offerings, removing those which have the least to offer

One in five organisations claim they will need to re-price

their products, with the largest and smallest insurers

most affected Thirty-five percent of those with less

than £100m in NWP and 75% of businesses with more

than £5bn in NWP expect to re-price

Not content with introducing Solvency II, European legislators are also focusing on international and other financial reporting standards Opportunities for insurers

to align these differing demands are hampered by a lack not only of clarity but also of coherence According

to the survey, interdependency with other change programmes is a top-three concern for businesses in implementing Solvency II

Fewer than half (43%) of respondents said they would take a single, integrated approach to implementing Solvency II and managing the transition to IFRS 4 Phase

II About two-thirds (64%) of the largest insurers said they would not try to integrate their response to the changes

However, two thirds of respondents do plan to align the reporting close processes of Solvency II with IFRS and a little over a third with MCEV

Mr Zink says the ABI has been lobbying strongly for better alignment of the various pieces of European legislation and encourages insurers to take an integrated approach where possible

Aligning interest

“We have had some success in dealing with discrepancies between Solvency II and IFRS; we lobbied

to align the two and we are moving towards that It is not helpful for different legislation to have several definitions for similar terms, which creates confusion and duplication of effort We will continue to lobby in this area,” he says

Deloitte comment – Francesco Nagari

When the Solvency II draft Directive was first published in July 2007, the International Accounting Standard Board (IASB) had also published its preliminary views on the future IFRS for insurance (IFRS 4 Phase II Discussion Paper)

At that point there was strong alignment between the two bases, both aiming at a market consistent valuation of insurance portfolios with day one profit recognised in IFRS financial statements The industry has lobbied the IASB to abandon that approach, deemed too volatile, in favour of a valuation that defers profit on day one (residual margin liability) and recognises it later based on the insurer’s own estimates Although the underlying building blocks of the valuation bases remain notionally the same (present value of expected cash flows and a risk margin liability) their detailed calculation is still apart in a number of areas, requiring careful assessment of Solvency II implementation decisions that may prove costly when IFRS 4 Phase II is implemented The IASB expects to approve the final IFRS 4 Phase II text in July

2011 with mandatory application from 2014 at the earliest, subject to EU endorsement

On the positive side, the draft level 2 rules appear to give insurers capital credit for the residual margin liability but require detailed reconciliations between the two bases to be published on a regular basis to the market and regulators

Figure 7 Do you plan to have a single integrated programme that will both implement Solvency II and manage the transition to IFRS 4 Phase II?

18%

43%

38%

Note: Figures do not add to 100% due to rounding

In his February speech addressing issues facing the

industry as it grapples with Solvency II, the FSA’s

Mr Sants recognised the significant cost burden the

legislation imposes Not only do insurers face their own

internal cost demands but the FSA will recover an

estimated £100m from the industry as a direct result of

imposing Solvency II Mr Sants claims the regulator will

“continue to work to minimise these costs” but the ABI

described the expense of Solvency II as “spiralling

upwards and out of control” and the issue still looms

large for respondents to the survey

Insurers with £500m to £1bn in NWP ranked cost as

their biggest concern in implementing the Directive,

while all other insurers ranked it as at least a

top-three worry

While two-fifths of insurers responding to the survey

said their budgets were fully signed off until the end of

next year, one in 10 insurers had not finalised their total

Solvency II cost while just over half (52%) had only

partial budgetary approval More non-life insurers (50%)

than life (30%) have had full budgetary approval

Where costs were decided, 20% of respondents expect

to spend less than £1m on Solvency II Insurers with NWP below £500m typically expected to spend less than £5m While no insurer in our survey expects to pay over £100m on implementation, 36% of insurers with over £1bn in NWP are still undecided on their total budget Those larger insurers who have decided anticipate spending anywhere between £1m and £75m

Life and non-life companies had very similar cost expectations, with the majority expecting to pay less than £10m

Counting the cost

Figure 8 Which of the following best represents the stage

of your overall Solvency II budget (to 2012) in the approval

process?

7%

52%

41%

Budget signed off for part of Solvency II implementation

Complete budget signed off to the end of 2012

Budget submitted, awaiting approval

Figure 9 Which of the following best represents your total budget for Solvency II (including technology spend), approved or otherwise?

3%

3%

0%

20%

33%

27%

£0 – £1m £1 – £5m £5 – £10m £10 – £25m

£25 – £50m £50 – £75m

£100m+ Not decided

£75 – £100m 0%

Deloitte comment – Rick Lester

Accurate budgeting for Solvency II has been an ongoing challenge for insurers, regardless of when they began the planning process In part this has been driven by the unique scale of change Solvency II requires, but also the lack of clarity around the final requirements, which remains a top concern for respondents

The full cost implications of any large scale change programme are rarely transparent or easily quantifiable in advance This is highlighted in the data,

as 12% of all respondents and 36% of larger insurers are still undecided on their total budget

This lack of a final decision on overall budget, even at this late stage, may highlight that these insurers are struggling to quantify the full cost implications of their programme

Commenting on the drivers of cost Mr Zink said:

“A massive expense lies in the IT upgrade Obviously it depends on where you start from and how developed the company is internally which determines how much

of an upgrade you need.”

Figure 10 How many FTE (Full Time Employees) do you predict to be involved in delivery

of your Solvency II programme at any one time over the course of 2011?

%

0

10

20

30

40

50

60

100 plus

50 to 100

20 to 50

10 to 20

0 to 10

Unsurprisingly the largest insurers said they would need the highest amount of full-time employees to deal with the new legislative demands, with a quarter of those with NWP over £5bn and 16% of those with NWP between £1bn and £5bn expecting to dedicate more than 100 personnel to implementing Solvency II

On average, insurers said they needed fewer than

20 full-time employees and that a third of Solvency II preparations and implementation would be undertaken

by contractors

All respondents have at least 20% of the full-time staff required already in place More than one in 10 (12%) reported that all the requisite full-time staff had been appointed, two thirds of which are the smaller insurers, although this is most likely because they have a smaller number of positions to fill