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The Actuary The magazine of the Institute & Faculty of Actuaries
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Solvency II: QIS5: The end of the beginning

What was QIS5 and why did we do it?
The fifth quantitative impact study (QIS5) took approximately 1,500 person-months of actuarial resource across the UK industry last autumn, and so will be a topic very close to the heart of many readers. It was the largest and most comprehensive QIS5 exercise undertaken for Solvency II and may be the largest such exercise ever undertaken in the world. In the words of the European Insurance and Occupational Pensions Authority (EIOPA), it will be the last.

The exercise was designed to test a near-final implementation of Solvency II, and provided three main benefits:
1. A close to final chance to assess the potential financial impact of Solvency II on firms. With the clock ticking until implementation, QIS5 was seen by most firms as a vital opportunity to understand the likely effect of the new regime on their capital position. Many firms will be using the findings from QIS5 to drive business decisions on both the quantitative and qualitative elements and inform senior management of the likely impact of the new regime. For this reason we expect some firms will calculate their QIS5 results on year-end 2010 and even half-year figures.
2. As ‘go live’ for Solvency II looms ever nearer, QIS5 provided an excellent opportunity to test the preparedness of the firm to perform the required calculations. There is still time to take action where systems were unable to perform the calculations to the required auditable and publishable standards under Solvency II.
3. An invaluable learning exercise for EIOPA and the European Commission. Over the coming months the quantitative aspects of Solvency II will be finalised, and throughout this process the decision makers are leaning heavily on the results that have been gathered from the exercise.

The feedback provided in the qualitative questionnaire will dictate if and where simplifications are added, and where guidance will be provided by EIOPA to help actuaries perform the required technical calculations.

The financial results are also helping to inform decisions and discussions in Europe on some of the key outstanding financial concepts in Solvency II. These include the liquidity premium, expected profits in future premiums (EPIFP), the levels of calibration for non-life and catastrophe risk, and many others.

Who took part?
We were very pleased by the participation in QIS5. Around 70% of UK insurance companies took part, covering the vast majority of the industry by market share, and more than twice as many took part as did for QIS4. In terms of quality of submissions, we were pleased to see the amount of effort put into the exercise by firms, approximately double the resource as was committed to QIS4.

This excellent level of participation and resource commitment clearly reflects the importance firms attached to this exercise; it was a key milestone for the Solvency II implementation project and treated with a high degree of importance by the Commission and national regulators. Particularly pleasing was the increased involvement from smaller insurers, around three times as many took part in QIS5 than in QIS4.

The FSA and EIOPA QIS5 reports both give many further details on the capital impacts of various parts of the regime and are available at www.fsa.gov.uk/Solvency2. In the coming months, it will be important that clear guidance is provided on the issues that proved difficult, such as contract boundaries or the risk margin, and EIOPA and the FSA are working on this guidance.

The headline figures
The EIOPA report noted that the total UK industry surplus has reduced from €62bn under Solvency I, to €35bn under QIS5. However, this €27bn fall substantially overstates the total capital effect of QIS5 for four main reasons. First, the change is measured with respect to Solvency I (Pillar 1) figures — for many firms the fall in surplus from the biting ICAS regime is significantly less pronounced.

Second, the total surplus looks only at the ‘standard formula’, and the application of internal models may provide lower capital requirements in some cases.

Third, the effect of transitional provisions aimed at smoothing the capital impact from Solvency I to Solvency II was not included. These transitionals can provide very high levels of capital relief, for example a discount rate transitional was tested which reduced required capital by €4bn for UK annuity writers alone.

Finally, QIS5 necessarily didn’t take account of the likely management actions in the run-up to Solvency II, and again these will provide significant levels of relief. The overall surplus figures mask significant variation between firms. Figure 1 shows the dispersion of the evolution of surplus from Solvency I to QIS5 split by life and non-life firms.

The graph illustrates that some firms saw significant increase to their surplus, and others marked decreases. 81% of firms across the industry met their solvency capital requirement (SCR), and the vast majority met their minimum capital requirement (MCR).

The 19% of firms that did not meet their SCR fall into three broad categories, annuity writers, protection and indemnity clubs, and firms with large amounts of unrated reinsurance. For these firms transitional arrangements and internal models may provide significant capital relief, but they should be closely monitoring their capital positions as new business plans take shape and the regime becomes finalised.

What happens next?
In line with many firms, the FSA saw the QIS5 exercise as a key milestone in its Solvency II implementation programme. During the exercise we answered 600 questions and committed vast supervisory resource to understanding the QIS5 results on a firm-by-firm basis. The FSA is using the QIS5 results as a springboard in its supervisory discussions with firms, as we work together to ensure that the implications of the new regime are fully understood, and that preparation for implementation is well under way.

The European Commission, Finance Ministries, EIOPA and national regulators are all hard at work to finalise the quantitative details of Solvency II (in the delegated acts, which used to be known as the level 2 implementing measures), and to provide guidance for how the calculations should be performed. Things are moving fast, and the QIS5 results and feedback have been, and will continue to be, a key input to the policy development process. It is for this reason that we are so grateful for all of the hard work done by the UK industry to complete the exercise to such a high standard.

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Will there be a QIS6?
The QIS5 process took 15 months from inception in January 2010 to final reporting in March 2011. Given the time to implementation (proposed as 1 January 2013 — just 18 months away) it is difficult to see room for a further exercise of this scale, as noted by Carlos Montalvo on being elected executive director of EIOPA, when he said, “QIS5 is the last one. It is simply too late to undertake another full exercise before the implementation”.

There will be further impact analyses, in part this will be through modelling performed by the regulators, and in part through exercises smaller in scope than QIS5 aimed at gathering particular data points, or targeting particular sectors. Further, it is part of EIOPA’s mandate to perform ‘stress tests’ to assess systemic risk (the first of which is well under way as this article goes to press), and we can expect these to take place annually.

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Anthony Brown is a senior policy actuary at the FSA and was the FSA lead for QIS5