Solvency ii and return on equity; optimizing capital and manage the risk
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This document discusses Solvency II requirements, return on equity, risk appetite, and risk management frameworks. It introduces Solvency II's three pillars for quantitative capital requirements, qualitative requirements, and reporting. It describes how return on equity measures profitability for shareholders and how Solvency II requires linking capital to actual risks. It defines risk appetite, tolerance, and capacity, and how boards should establish a risk appetite. Finally, it outlines how to optimize capital allocation, the roles of risk and compliance functions, and the connection between returns, capital, risk-taking, and risk management programs.
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Solvency ii and return on equity; optimizing capital and manage the risk
- 1. Solvency II and return on equity; optimizing capital and manage the risk Maria Haug Edvardsen GRC 2016, May 19
- 2. Content • Solvency II introduction • return on equity • risk appetite and risk tolerance • framework on risk management ©TranscendentGroupNorgeAS2016
- 3. Solvency II - the basics ©TranscendentGroupNorgeAS2016
- 4. 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. ©TranscendentGroupNorgeAS2016
- 5. 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» ©TranscendentGroupNorgeAS2016
- 6. 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) Buffer New Solvency II balance ©TranscendentGroupNorgeAS2016
- 7. Pillar II • governance • fit and proper • risk management • ORSA • internal controls • internal audit • actuarial function • outsourcing ©TranscendentGroupNorgeAS2016
- 8. 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) ©TranscendentGroupNorgeAS2016
- 10. 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. ©TranscendentGroupNorgeAS2016
- 11. 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. ©TranscendentGroupNorgeAS2016
- 12. Risk appetite and risk tolerance ©TranscendentGroupNorgeAS2016
- 13. 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? ©TranscendentGroupNorgeAS2016
- 14. Risk appetite and risk tolerance Risk universe Risk capacity Risk tolerance Risk appetite ©TranscendentGroupNorgeAS2016
- 15. Risk Appetite ©TranscendentGroupSverigeAB2016 Risk too low Risk Appetite Risk too high Target Limit Tolerance Risk Capacity
- 16. Risk appetite – how to define it? Source: Institute of International Finance: ”Implementing robust risk appetite frameworks to strengthen financial institutions”, 2011 ©TranscendentGroupNorgeAS2016
- 17. 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 ©TranscendentGroupNorgeAS2016
- 18. 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? ©TranscendentGroupNorgeAS2016
- 20. 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. ©TranscendentGroupNorgeAS2016
- 21. 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) ©TranscendentGroupNorgeAS2016
- 22. 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 ? ©TranscendentGroupNorgeAS2016
- 23. Solvencymargin (%) = Available capital/SCR Minimum 100 % Risk capital Zone Solvencymargin (examples) red < 120% yellow 120-160% green 160-200% yellow >200% ©TranscendentGroupNorgeAS2016
- 24. Distribution of risk capital 45 30 10 15Example: Risk appetite pr. category or products Goal: to optimize the allocation of capital ©TranscendentGroupNorgeAS2016
- 26. Riskunivers & risk capital Strategic risks Insurance risks Financial risks Operational risks Other risks Aggregated risk Risk capital Policies and mandates ©TranscendentGroupNorgeAS2016
- 27. Risk management framework Risk appetite and risk tolerance Governance, organization and people Strategy and policy Internal controls and assurance Risk identification, transfer, mitigation and reporting ©TranscendentGroupNorgeAS2016
- 28. Risk function • aggregated view on risk (today and forward) • integrated part of the business processes • ORSA • risk reporting • fit and proper • capacity • authority ©TranscendentGroupNorgeAS2016
- 29. 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 ©TranscendentGroupNorgeAS2016
- 30. To sum up • Is there a connection between the desired returns, established capital, actually risk-taking and an adequate risk management program? ©TranscendentGroupNorgeAS2016
- 32. Maria Haug Edvardsen • Partner & Head of department • Transcendent Group Norway • mhe@transcendentgroup.com • +47 992 711 80 ©TranscendentGroupNorgeAS2016