Glossary
of Terms
The
following Glossary of terms was published in a paper called "Solvency II:
a new framework for prudential regulation of insurance in the EU".
© Crown copyright 2006
Asset Liability Management: the process of analysing the interaction
between the risks to assets and its liabilities. One example in insurance is
duration risk which arises where assets and liabilities have different
maturities.
Australian Prudential Regulatory Authority (APRA): the prudential
regulator of the Australian financial services industry.
Best estimate: the expected value or
probability-weighted average of a random variable.
Capital Requirements Directive (CRD): the amendments to
EU directives implementing Basel II for credit institutions and investment
business (Banking Coordination Directive, 2000/12/EC, and Capital Adequacy
Directive, 93/6/EEC).
Committee of European Insurance and Occupational Pensions
Supervisors (CEIOPS): one of the Lamfalussy 'level 3'
committees which develops guidance to promote consistent application of Lamfalussy directives. The other level 3 committees are the
Committee of European Banking Supervisors (CEBS) and the Committee of European
Securities Regulators (CESR). CEIOPS also provides technical advice to the
European Commission on the development of the Solvency II framework and other
policy issues.
Cost of capital approach a method for estimating the value
of insurance liabilities on a market consistent basis in the absence of a
market price. The liability is valued at the best estimate plus a risk margin
which is assumed to be the cost to the insurer of bearing the risk in the
liability. That cost is the product of the amount of capital
required (e.g. to meet regulatory requirements) and its price.
Diversification benefits the reduction in the level of
capital required by an insurer to achieve a given level of security (e.g.
credit rating) compared with the level which would be needed if all risks were
assumed to be perfectly correlated.
Economic capital the amount of capital that an insurer
would actually require to bear the risks it takes on in the absence of
regulatory requirements. Economic capital is a function of the targeted level
of security and the insurer's capacity to assess, mitigate and manage risks.
European Insurance and Occupational Pensions Committee
(EIOPC):
the level 2 Lamfalussy committee of Member States
chaired by the EU Commission. EIOPC will develop the level 2 implementing
measures within the scope of the Solvency II framework directive (level 1). It
also advises the Commission on insurance matters more generally.
Eligible capital the forms of capital which firms can rely
on to meet the solvency requirements.
Enhanced Capital Requirement (ECR) a capital
requirement imposed by the FSA on
Fair (market consistent) value the price at
which transactions would occur at arms' length between willing parties.
Financial Services Action Plan (FSAP) the EU's legislative framework for developing the Single Market
in financial services.
Financial Services Authority (FSA) the
Financial Conglomerates Directive (FCD) the directive
which makes provision for group-wide supervision of companies which have
subsidiaries operating in more than one financial sector (2002/87/EC).
Hedgeable
risk
a risk that can be hedged and thus priced through purchase of a financial
instrument, for example a derivative.
Individual Capital Adequacy Standards (ICAS) the FSA's
framework that
Individual Capital Guidance (ICG) the FSA's guidance
about the minimum quality and level of capital that a firm needs to hold, which
is provided following the firm's ICAS submission.
Insurance Groups Directive (IGD) the EU Directive
which applies Solvency I regulatory capital requirements to insurance groups
and makes provisions for group supervision (98/78/EC).
Internal Model: a model which represents the (material)
assets and liabilities on an insurer's balance sheet and can be used to
forecast the impact on solvency of changes in relevant variables e.g. financial
market prices, adverse deviation in underwriting results etc.
International Accounting Standards Board (IASB): independent
accounting standard-setter based in
International Monetary Fund (IMF): an international
organization established to promote international monetary cooperation; to
foster economic growth and high levels of employment; and to provide temporary
financial assistance to countries to help ease balance of payments adjustment.
International Association of Insurance Supervisors (IAIS): represents
insurance regulators and supervisors worldwide; the IAIS issues global
insurance principles and standards.
International Financial Reporting Standards (IFRS)>: accounting
standards set by the IASB; listed EU companies have been required to produce
their accounts using IFRS since 2005.
Lamfalussy arrangements the arrangements
designed to enable the EU to develop and update financial services legislation
more quickly and easily. Under this approach, directives set out high-level
principles and define the scope for implementing measures. The latter are
decided by the Commission in consultation with Member States in the level 2
committees and taking into account technical advice from the level 3
supervisors' committee.
Minimum Capital Requirement (MCR): the level of
capital required by Solvency II below which there would be an unacceptable risk
to policyholders and which triggers "ultimate" supervisory
intervention requiring the firm to restore rapidly the level of solvency.
Minimum Guarantee Fund (MGF): the minimum
amount of capital required under Solvency I. For most
insurers the greater of one third of the Regulatory Minimum Margin or
€4million.
Pillars 1, 2, 3: the three-pillar structure which will be
applied to Solvency II, derived from the Basel II reforms to banking
supervision. Pillar 1 will define a quantitative standard for technical
provisions and the regulatory capital requirements; Pillar 2 will define the
supervisory review process and Pillar 3 the regulatory disclosures firms will
be required to make publicly and to supervisors.
Prudent Person: a principle which guides asset management
by requiring the manager to invest as a prudent person would do.
Prudential margin: a margin added to the best estimate of an
insurance liability which to reflect the uncertainties in the underlying
liability. An appropriate prudential margin reflects the cost of capital
required by the market to bear the risk of holding the liability (also referred
to as fair or market consistent valuations).
Quantitative Impact Study: study undertaken by CEIOPS to
quantify the impact of the proposed Solvency II reforms on firms' regulatory
capital requirements.
Required Minimum Margin (RMM): the main Solvency
I capital requirement, calculated as a proportion of technical provisions.
Regulatory arbitrage: the process of minimising the costs
imposed by regulation through exploiting the differences between regulatory
regimes across sectors.
Risk Capital Margin (RCM) a term used by the FSA to refer to
the risk-based capital requirements that is added to the realistic valuations
of life insurance firms' liabilities where the firm has a
with-profits funds of more than £500m.
Risk-free (interest) rate: the rate of return available on an
asset which has no or negligible credit risk. Risk mitigation
techniques methods of transferring risk including reinsurance but also through
derivatives and other financial instruments.
Run-off period: the period of time over which any claim
made under an insurance contract is settled.
Solvency I catch-all term for
the current set of Directives governing the prudential regulation of insurance
in the EU.
Solvency II: the new EU framework for prudential
regulation of insurance companies.
Solvency Capital Requirement (SCR): the risk-based
capital requirement and key solvency control level in Solvency II. Firms may
use internal models to estimate the SCR or the standardised approach.
Pillar 1 SCR: the SCR determined by the standardised
approach or the firm's internal model, before consideration of the implications
of the Pillar 2 supervisory review process for the firms capital requirement.
Adjusted SCR: the SCR level reflecting the Pillar 2
supervisory review process including, for example, the results of stress and
scenario testing.
Standardised approach (to the SCR) approach to calculating the
SCR which prescribes a method for firms to apply; for example in non-life
insurance it is likely that the standardised approach will be formula-based.
Supervisory co-operation: processes designed to achieve
effective regulation of cross border groups and consistent application of the
relevant directives to insurers across the EU.
Surrender Value Floor: a minimum value for an insurance
liability set by the value an insurer would pay if the policyholder surrendered
the policy.
Technical provisions: the regulatory valuation of insurance
liabilities.
Unbiased valuation: (of an insurance liability) the best
estimate plus a margin which reflects the true uncertainty in the insurance
liability.
Tier 1, 2: capital types of eligible capital defined in the
banking sector. Tier 1 includes share capital; it represents a higher quality
of capital than Tier 2 which includes certain forms of subordinated debt.
Value-at-Risk: the maximum loss a firm could sustain
over a given period of time and with a given probability; also refers more
generally to the methods used to estimate this value.
© Crown copyright: '2006 Solvency II: a new framework for prudential regulation
of insurance in the EU A discussion paper'
Contact Secretariat: Richard Camp
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