Solvency Assessment and Management: Pillar I - Sub Committee
Capital Resources and Capital Requirements Task Groups
Discussion Document 53 (v 10)
Treatment of participations in the solo entity submission under SAM
EXECUTIVE SUMMARY
This document discusses the considerations regarding the treatment of participations in the
solo entity submission under SAM. It makes the following recommendations:
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–
–
–
–
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The criteria used to determine whether an investment is a participation should be as specified
under Solvency II (by virtue of share ownership or by virtue of the exertion of dominant or
significant influence). Details of these are provided.
No distinction should be made between strategic and other participations, unlike under
Solvency II.
The definition of a financial and credit institution (F&CI) should be similar to that specified under
Solvency II. Details of this are provided.
Participations should be valued at fair value, in line with SAM position paper 39.
Non-financial participations should be considered under and stressed by the appropriate equity
stress (SA, global, or other equity).
Non-South African (re)insurance participations should be treated in the same way as South
African equivalents.
Consensus could not be reached on the following points and hence no final recommendation
is made. In each instance two possible approaches are specified.
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The treatment of F&CI participations in own funds and the SCR: View 1 is to align the treatment of
these closely with the equivalent under Basel III; View 2 is to treat these exactly as specified in
EIOPA-DOC-12/467.
The treatment of South African (re)insurance participations in own funds and the SCR: View 1 is
to consider these under a separate participations risk module (possibly modules) with a stress
determined as a function of the participation‘s SCR-coverage. View 2 is to treat these exactly as
specified in EIOPA-DOC-12/467 (i.e. as standard equity investments).
The treatment of participations in the concentration risk module: View 1 is to include participations
in the concentration risk module unless the specifics of the risk profile are reflected elsewhere
(e.g. under the treatment of F&CI participations or view 1 for (re)insurance participations). View 2
is to treat participations in the concentration risk module exactly as specified in EIOPA-DOC12/467 (i.e. exclude participations from the concentration risk module provided certain criteria are
met).
Both views allow for the risk associated with F&CI participations through deductions from
own funds and allow for the risk associated with other participations through the calculation
of the capital requirement.
Solvency Assessment and Management: Pillar I - Sub Committee – Capital Resources & Capital Requirements Task Groups
Discussion Document 53 (v 10) – Treatment of participations in the solo entity submission under SAM
1. INTRODUCTION AND PURPOSE
The (re)insurance industry invests in a variety of assets, including ―participations‖. These are
companies in which the (re)insurer owns a significant proportion of the issued share capital
or over which it exerts significant influence / control.
The purpose of this document is to set out the treatment of participations for the solo entity
submission of (re)insurers under SAM. This includes their treatment in the balance sheet,
own funds and the solvency capital requirement calculations.
To this end, various IAIS documents, the Solvency II principles and the guidance available in
other jurisdictions (specifically Canada and Australia) are considered. The appropriateness
of the various approaches is assessed in the South African context. Three categories of
participation are considered: financial and credit institutions, (re)insurance companies, and
other (non-financial) participations. Furthermore, the concept of ―strategic‖ participations is
discussed.
Where consensus on treatment was reached a final recommendation is presented. Where
consensus could not be reached separate recommendations in line with each viewpoint are
presented.
The document also recommends a technical definition of participations for use in SAM.
2. INTERNATIONAL STANDARDS: IAIS ICPs
International Association of Insurance Supervisors (IAIS) Insurance Core Principle (ICP) 17
Capital Adequacy, adopted 1 October 2011 is considered in this section.
The portions of this ICP that are relevant to the topic covered in this discussion document
consist of Section 17.10 (―Identification of capital resources potentially available for solvency
purposes‖) and Section 17.11 (―Criteria for the assessment of the quality and suitability of
capital resources‖ and ―Determination of capital resources to meet regulatory capital
requirements‖).
2.1 Paragraphs 17.10.12 to 17.10.14:
Treatment of assets which may not be fully realisable on a going-concern or wind-up basis
17.10.12 Supervisors should consider that, for certain assets in the balance sheet, the
realisable value under a wind-up scenario may become significantly lower than
the economic value which is attributable under going-concern conditions.
Similarly, even under normal business conditions, some assets may not be
realisable at full economic value, or at any value, at the time they are needed.
This may render such assets unsuitable for inclusion at their full economic value
for the purpose of meeting required capital.
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Discussion Document 53 (v 10) – Treatment of participations in the solo entity submission under SAM
17.10.13 Examples of such assets include:






…
intangible assets: their realisable value may be uncertain even during normal
business conditions and may have no significant marketable value in run-off or
winding-up; Goodwill is a common example;
future income tax credits: such credits may only be realisable if there are future
taxable profits, which is improbable in the event of insolvency or winding-up;
…
investments in other insurers or financial institutions: such investments may have
uncertain realisable value because of contagion risk between entities; also there is
the risk of ―double gearing‖ where such investments lead to a recognition of the
same amount of available capital resources in several financial entities; and
company-related assets: certain assets carried in the accounting statements of the
insurer could lose some of their value in the event of run-off or winding-up, for
example physical assets used by the insurer in conducting its business which may
reduce in value if there is a need for the forced sale of such assets. Also, certain
assets may not be fully accessible to the insurer e.g. surplus in a corporate pension
arrangement.
17.10.14 The treatment of such assets for capital adequacy purposes may need to
reflect an adjustment to its economic value. Generally, such an adjustment may
be effected either:


directly, by not admitting a portion of the economic value of the asset for solvency
purposes (deduction approach); or
indirectly, through an addition to regulatory capital requirements (capital charge
approach).
2.2 Paragraph 17.10.19
In paragraph 17.10.19 it is stated that when a supervisor considers the approach to adopt to
treat assets that might not be fully realisable on a going-concern or wind-up basis, it should:
17.10.19 …choose the approach which is best suited to the organisation and
sophistication of the insurance sector and the nature of the asset class and
asset exposure considered. It may also combine different approaches for
different classes of assets. Whatever approach is chosen, it should be
transparent and consistently applied. It is also important that any material
double counting or omission of risks under the calculations for determining the
amounts of required and available regulatory capital is avoided.
2.3 Paragraph 17.10.21
Paragraph 17.10.21 lists factors that may be considered by the supervisor in identifying
what may be regarded as capital resources for solvency purposes. The factors includes
systemic risks which could affect the amount and/or quality of capital resources and the
relationship between risks faced by insurers and those faced by other financial services
entities, including banks.
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Discussion Document 53 (v 10) – Treatment of participations in the solo entity submission under SAM
2.4 Paragraph 17.11.19
17.11.19 The availability of capital instruments may also be impaired when capital is not
fully fungible within an insurer to cover losses arising from the insurer‘s
business. Whereas the fungibility of capital and transferability of assets is
primarily an issue in the context of group solvency assessment, it may also be
relevant for the supervision of an insurer as a legal entity.
2.5 Paragraphs 17.11.46 to 17.11.51
Paragraphs 17.11.46 to 17.11.51 cover additional guidance for insurance groups and
insurance legal entities that are members of groups.
Multiple gearing and intra-group creation of capital
17.11.46 Double gearing may occur if an insurer invests in a capital instrument that
counts as regulatory capital of its subsidiary, its parent or another group entity.
Multiple gearing may occur if a series of such transactions exist.
17.11.47 Intra-group creation of capital may arise from reciprocal financing between
members of a group. Reciprocal financing may occur if an insurance legal
entity holds shares in or makes loans to another legal entity (either an
insurance legal entity or otherwise) which, directly or indirectly, holds a capital
instrument that counts as regulatory capital of the first insurance legal entity.
17.11.48 For group-wide capital adequacy assessment with a group level focus, a
consolidated accounts method would normally eliminate intra-group
transactions and consequently multiple gearing and other intra-group creation
of capital whereas, without appropriate adjustment, a legal entity focus may
not. Whatever approach is used, multiple gearing and other intra-group
creation of capital should be identified and treated in a manner deemed
appropriate by the supervisor to largely prevent the duplicative use of capital.
Leverage
17.11.49 Leverage arises where a parent, either a regulated company or an unregulated
holding company, issues debt or other instruments which are ineligible as
regulatory capital or the eligibility of which is restricted and down-streams the
proceeds as regulatory capital to a subsidiary. Depending on the degree of
leverage, this may give rise to the risk that undue stress is placed on a
regulated entity as a result of the obligation on the parent to service its debt.
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Discussion Document 53 (v 10) – Treatment of participations in the solo entity submission under SAM
Fungibility and transferability
17.11.50 In the context of a group-wide solvency assessment, excess capital in an
insurance legal entity above the level needed to cover its own capital
requirements may not always be available to cover losses or capital
requirements in other insurance legal entities in the group. Free transfer of
assets and capital may be restricted by either operational or legal limitations.
Some examples of such legal restrictions are exchange controls in some
jurisdictions, surpluses in with-profits funds of life insurers which are earmarked
for the benefit of policyholders and rights that holders of certain instruments
may have over the assets of the legal entity. In normal conditions, surplus
capital at the top of a group can be down-streamed to cover losses in group
entities lower down the chain. However, in times of stress such parental
support may not always be forthcoming or permitted.
17.11.51 The group-wide capital adequacy assessment should identify and appropriately
address restrictions on the fungibility of capital and transferability of assets
within the group in both ―normal‖ and ―stress‖ conditions. A legal entity
approach which identifies the location of capital and takes into account legally
enforceable intra-group risk and capital transfer instruments may facilitate the
accurate identification of, and provision for, restricted availability of funds.
Conversely an approach with a consolidation focus using a consolidated
accounts method which starts by assuming that capital and assets are readily
fungible/transferable around the group will need to be adjusted to provide for
the restricted availability of funds.
3. EU DIRECTIVE ON SOLVENCY II: PRINCIPLES (LEVEL 1)
Content that relates to the treatment of participations are reproduced below:
From Article 92, titled “Implementing measures” in the “OWN FUNDS” section:
1. The Commission shall adopt implementing measures specifying the following:
(a) …;
(b) the treatment of participations, within the meaning of the third subparagraph of Article 210(2), in
financial and credit institutions with respect to the determination of own funds.
Those measures designed to amend non-essential elements of this Directive, by supplementing it,
shall be adopted in accordance with the regulatory procedure with scrutiny referred to in Article
304(3).
2. Participations in financial and credit institutions as referred to in point (b) of paragraph 1 shall
comprise the following:
(a) participations which insurance and reinsurance undertakings hold in:
(i) credit institutions and financial institutions within the meaning of Article 4(1) and (5) of Directive
2006/48/EC,
(ii) investment firms within the meaning of point 1 of Article 4(1) of Directive 2004/39/EC;
(b) subordinated claims and instruments referred to in Article 63 and Article 64(3) of Directive
2006/48/EC which insurance and reinsurance undertakings hold in respect of the entities defined in
point (a) of this paragraph in which they hold a participation.
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Discussion Document 53 (v 10) – Treatment of participations in the solo entity submission under SAM
Article 216, titled “Supervision of group solvency”
1. Supervision of the group solvency shall be exercised in accordance with paragraphs 2 and 3,
Article 250 and Chapter III.
2. In the case referred to in point (a) of Article 211(2), Member States shall require the participating
insurance or reinsurance undertakings to ensure that eligible own funds are available in the group
which are always at least equal to the group Solvency Capital Requirement as calculated in
accordance with Subsections 2, 3 and 4.
3. In the case referred to in point (b) of Article 211(2), Member States shall require insurance and
reinsurance undertakings in a group to ensure that eligible own funds are available in the group which
are always at least equal to the group Solvency Capital Requirement as calculated in accordance with
Subsection 5.
From Article 220, titled “Elimination of double use of eligible own funds”
1. The double use of own funds eligible for the Solvency Capital Requirement among the different
insurance or reinsurance undertakings taken into account in that calculation shall not be allowed.
For that purpose, when calculating the group solvency and where the methods described in
Subsection 4 do not provide for it, the following amounts shall be excluded:
(a) the value of any asset of the participating insurance or reinsurance undertaking which represents
the financing of own funds eligible for the Solvency Capital Requirement of one of its related
insurance or reinsurance undertakings;
(b) the value of any asset of a related insurance or reinsurance undertaking of the participating
insurance or reinsurance undertaking which represents the financing of own funds eligible for the
Solvency Capital Requirement of that participating insurance or reinsurance undertaking;
(c) the value of any asset of a related insurance or reinsurance undertaking of the participating
insurance or reinsurance undertaking which represents the financing of own funds eligible for the
Solvency Capital Requirements of any other related insurance or reinsurance undertaking of that
participating insurance or reinsurance undertaking.
…
5. Any eligible own funds of a related insurance or reinsurance undertaking of the participating
insurance or reinsurance undertaking for which the group solvency is calculated that are subject to
prior authorisation from the supervisory authority in accordance with Article 89 may only be included
in the calculation in so far as they have been duly authorised by the supervisory authority responsible
for the supervision of that related undertaking.
Article 221, titled “Elimination of the intra-group creation of capital”
1. When calculating group solvency, no account shall be taken of any own funds eligible for the
solvency capital requirement arising out of reciprocal financing between the participating insurance or
reinsurance undertaking and any of the following:
(a) a related undertaking;
(b) a participating undertaking;
(c) another related undertaking of any of its participating undertakings.
2. When calculating group solvency, no account shall be taken of any own funds eligible for the
Solvency Capital Requirement of a related insurance or reinsurance undertaking of the participating
insurance or reinsurance undertaking for which the group solvency is calculated when the own funds
concerned arise out of reciprocal financing with any other related undertaking of that participating
insurance or reinsurance undertaking.
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Discussion Document 53 (v 10) – Treatment of participations in the solo entity submission under SAM
3. Reciprocal financing shall be deemed to exist at least when an insurance or reinsurance
undertaking, or any of its related undertakings, holds shares in, or makes loans to, another
undertaking which, directly or indirectly, holds own funds eligible for the Solvency Capital
Requirement of the first undertakings.
Article 226, titled “Related credit institutions, investment firms and financial
institutions”
When calculating the group solvency of an insurance or reinsurance undertaking which is a
participating undertaking in a credit institution, investment firm or financial institution, Member States
shall allow their participating insurance and reinsurance undertakings to apply mutatis mutandis
methods 1 or 2 set out in Annex I to Directive 2002/87/EC. However, method 1 set out in that Annex
shall be applied only if the group supervisor is satisfied as to the level of integrated management and
internal control regarding the entities which would be included in the scope of consolidation. The
method chosen shall be applied in a consistent manner over time.
Member States shall however allow their supervisory authorities, where they assume the role of group
supervisor with regard to a particular group, to decide, at the request of the participating undertaking
or on their own initiative, to deduct any participation as referred to in the first paragraph from the own
funds eligible for the group solvency of the participating undertaking.
Article 227, titled “Non-availability of the necessary information”
Where the information necessary for calculating the group solvency of an insurance or reinsurance
undertaking, concerning a related undertaking with its head office in a Member State or a thirdcountry, is not available to the supervisory authorities concerned, the book value of that undertaking
in the participating insurance or reinsurance undertaking shall be deducted from the own funds
eligible for the group solvency.
In that case, the unrealised gains connected with such participation shall not be recognised as own
funds eligible for the group solvency.
Article 231, titled “Method 2 (Alternative method): Deduction and aggregation
method”
….
2. The aggregated group eligible own funds are the sum of the following:
(a) the own funds eligible for the Solvency Capital Requirement of the participating insurance or
reinsurance undertaking;
(b) the proportional share of the participating insurance or reinsurance undertaking in the own funds
eligible for the Solvency Capital Requirement of the related insurance or reinsurance undertakings.
…
4. Where the participation in the related insurance or reinsurance undertakings consists, wholly or in
part, of an indirect ownership, the value in the participating insurance or reinsurance undertaking of
the related insurance or reinsurance undertakings shall incorporate the value of such indirect
ownership, taking into account the relevant successive interests, and the items referred to in points
(b) of the second and third paragraphs shall include the corresponding proportional shares of the own
funds eligible for the Solvency Capital Requirement of the related insurance or reinsurance
undertakings and of the Solvency Capital Requirement of the related insurance or reinsurance
undertakings, respectively.
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Discussion Document 53 (v 10) – Treatment of participations in the solo entity submission under SAM
Article 92 of the SAM primary legislation is the same Article 92 from the Level 1 text above,
except that references to articles and directives were replaced by SAM-specific references.
Alternatively, the reference was replaced by phrases of the form ―as shall be determined by
the FSB (or as prescribed in the subordinate legislation)‖.
4. MAPPING ANY PRINCIPLE (LEVEL 1) DIFFERENCES BETWEEN IAIS ICP & EU
DIRECTIVE
Section 3 of the Solvency II Level 1 principles does not go into as much detail as Section
17.10 and Section 17.11 of ICP 17 (―Capital Adequacy‖), but also does not contradict any of
the principles stated by the IAIS.
5. STANDARDS AND GUIDANCE (LEVELS 2 & 3)
5.1 IAIS standards and guidance papers
There are several principles in other IAIS documents that could indirectly affect the treatment
of participations in an insurer‘s own funds and solvency capital requirement. For example,
the topics of group supervision, non-regulated entities, financial conglomerates, systemic
aspects, off-balance sheet exposures, liquidity risks, diversification/concentration, contagion
and reputational risk are all mentioned in other IAIS documents. These sections were
omitted from this discussion document because it would be covered by other discussion
documents and is outside the scope of this document.
5.2 CEIOPS CPs (consultation papers) and EIOPA guidance
5.2.1
CEIOPS Principles
CEIOPS‘ Advice for Level 2 Implementing Measures on Solvency II titled ―Treatment of
participations‖ (CEIOPS-DOC-63/10, former Consultation Paper 67) aims at providing advice
on the treatment of participations for the determination of own funds as required in Article 92
of the Solvency II Level 1 text.
The CEIOPS paper contains detail on the options considered and the majority and minority
views in respect of the preferred approaches. A brief summary of CEIOPS‘ advice is given
below.
CEIOPS‘ Members considered the following objectives to be relevant when considering the
treatment of participations.
a) Double gearing (example given in the paper).
b) Ensure that capital in each solo entity corresponds to the risk run in that entity.
c) Limit systemic risk.
d) Avoid contagion of risk within a group through subsidiaries/participations. Even though the
assessment may be done at group level, this is also relevant at solo level.
e) Avoid incentives to regulatory arbitrage through group structuring.
Some of these objectives will relate to both the solo and group treatment of participations,
depending on the structure of the (re)insurance undertaking.
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Financial and Credit Institutions
The majority view of CEIOPS members was that own funds from financial and credit
institutions should not be recognised as eligible own funds. This was based on two
arguments:


Identifying the SCR equivalent in these participations may be too complex; and
Any surplus capital may be subject to restrictions and thus own funds of such entities may
not be available to absorb losses in the parent
There were concerns that this approach is overly penal and thus there was a minority view
that financial and credit participations should be treated as equity investments at solo level
and thus be subject to the normal equity risk SCR charge.
(Re)insurance Participations
The vast majority of members considered that, of own funds which arise from (re)insurance
participations, at least the amount corresponding to the participation‘s SCR is not available
to absorb losses in the parent. Thus the amount equal to the participation‘s SCR should be
treated as a restricted item and excluded on a proportional basis from the parent‘s own
funds (¶6.10). Furthermore, any ―inherent goodwill in the valuation should be excluded from
own funds of the participating undertaking‖ (¶6.12). Finally, the excess of own funds over
SCR (in the participation) should be tested to determine whether it provides loss absorbency
capacity to the parent (¶6.13). Under CEIOPS‘ approach the parent would allow for the value
of the participation‘s own funds less SCR in the parent‘s own funds. This implies that any
difference between the value placed on the participation and attributable own funds less
SCR is excluded from the parent‘s own funds.
The CEIOPS minority view was that all participations should be addressed under the equity
risk module, possibly with a reduction in the equity risk charge for strategic participations
(suggested at 50%). This is the approach that was followed in QIS5 (and SA QIS1).
An investment in a (re)insurance participation may expose the parent to other risks besides
equity risk. This is not reflected directly in the SCR of the parent under the latter approach,
as discussed in CEIOPS-DOC-63/10 ¶A4.
The CEIOPS majority view approach allows for the risks associated with (re)insurance
participations through a reduction in own funds (¶6.10–6.14). The majority view also
provides an approach using the SCR (¶6.15) in annex A. The details of this are as follows:
–
–
The participations risk module is added to the BSCR. Alternatively, participations could be
considered in the equity risk sub-module but with ―correction factors‖ to allow for the associated
issues (re double gearing and diversification). (¶A.1)
The stress to the value of the participation is the SCR. Furthermore, ―any inherent goodwill in the
valuation of the participation caused by a mark-to-market vs. a Solvency II net asset approach‖
must be addressed through the intangible assets risk module. (¶A.2)
Financial Non-regulated Participations
The CEIOPS view was that these participations should be treated consistently with regulated
financial and credit participations. Under the majority view this would exclude the value of
the participation from the parent‘s own funds for purposes of solo reporting.
Non-Financial Non-regulated Participations
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Discussion Document 53 (v 10) – Treatment of participations in the solo entity submission under SAM
The CEIOPS view was that these participations should be treated as normal equity
investments.
5.2.2
CEIOPS Conclusion
In giving their advice, CEIOPS‘ members consider all the key regulatory objectives to be
relevant when considering the treatment of participations.
CEIOPS is of the opinion that the same method should apply regardless of whether the
related undertaking is a subsidiary or participation. The proposed treatments are presented
based on whether the participation is included in or excluded from the group and are also by
the nature of the participation. Consequently CEIOPS proposes the following with respect to
the solo treatment of participations for the determination of own funds. Note that the solo
treatment varies depending on whether the participation is included in the scope of the
parent‘s group supervision.
For participations included in the scope of group supervision
Own Funds
Regulated
Financial and credit
institutions
-
Do not recognise own funds (or ancillary own funds)
arising from the participation.
(Re)insurers
-
Exclude amount of participation‘s own funds required
to meet its own SCR.
-
Exclude inherent goodwill of participation.
-
The characteristics of the remaining own funds should
be tested to decide on further restrictions or the Tier in
which it should fall.
(An alternative approach is to relegate own funds to Tier 3
and make an appropriate adjustment to the SCR formula)
Unregulated
Related to the financial
sector
-
Do not recognise own funds (or ancillary own funds).
Not related to the
financial sector
-
Include at market value
For participations excluded from the scope of group supervision
If the participation is also excluded from assessment of the solo solvency position, then the
amount should not be recognised as eligible own funds. If the participation is included in the
assessment of the solo solvency position, treat the participation as if it were included in the
scope of group supervision.
5.2.3
EIOPA Technical Specifications:
On 21 December 2012, EIOPA released the ―Revised Technical Specifications for the
Solvency II valuation and Solvency Capital Requirements calculations‖, or EIOPA-DOC12/467. The preamble to this introduces it as a working document to be used by industry as
a guide to the quantitative assessment required under Solvency II while political discussions
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Discussion Document 53 (v 10) – Treatment of participations in the solo entity submission under SAM
are on-going. It is informed by the Omnibus 2 Directive, various working documents on the
Solvency II implementing measures, and EIOPA‘s own work in the development of the
technical standards.
EIOPA-DOC-12/467 therefore does not represent the final Solvency II technical
specifications. It does however contain valuable information regarding the possible final
requirements.
The following sections of EIOPA-DOC-12/467 are relevant to the treatment of participations
in Solvency II:
–
–
–
Paragraph V.8 on pages 8–9, which discusses the valuation of participations,
Section SCR.14 on pages 280–284 (Solo treatment of participations), and
Section SCR.5.9 on pages 161–162 (treatment of participations in the concentration risk module).
Parts of these are reproduced below.
Valuation of participations (¶V.8)
Holdings in related undertakings are to be valued at the quoted market price in an active
market. If this valuation is not possible:
1. Holdings in insurance and reinsurance undertakings
a. Subsidiary undertakings have to be valued with the equity method that is based on a
Solvency II consistent recognition and measurement for the subsidiary‘s balance sheet.
b. Related undertakings, other than subsidiaries, would also be valued with the equity
method using a Solvency II consistent recognition and measurement for the holding‘s
balance sheet. However, if this is not possible, an alternative valuation method in
accordance with the requirements in V1.1 and V1.2 should be used.
2. Holdings in undertakings other than insurance and reinsurance undertakings
a. Holdings in undertakings other than insurance and reinsurance undertakings have to be
valued with the equity method that is based on a Solvency II consistent recognition and
measurement for the subsidiary‘s balance sheet. If that is not practicable, the equity
method would be applied to the related undertaking‘s balance sheet following IFRSs as
endorsed by the European Commission – with the amendment that goodwill and other
intangible assets would need to be deducted. If this is not possible for related
undertakings, other than subsidiaries, an alternative valuation method in accordance with
the requirements in V1.1. and V1.2 should be used.
Section V.1.4 (―Consistency of [IFRSs] with Article 75‖) of EIOPA-DOC-12/467 provides
guidance on the interpretation ―the equity method‖ (which is from IAS28):
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IAS 28 prescribes the accounting for investments in associates and to set out the
requirements for the application of the equity method when accounting for investments in
associates and joint ventures.
Associates are accounted for using the equity method.
The equity method is a method of accounting whereby the investment is initially
recognised at cost and adjusted thereafter for the post-acquisition change in the
investor‘s share of the investee‘s net assets. The investor‘s profit or loss includes its
share of the investee‘s profit or loss and the investor‘s other comprehensive income
includes its share of the investee‘s other comprehensive income. The investor‘s share of
the profit or loss of the investee is recognised in the investor‘s profit or loss. Distributions
received from an investee reduce the carrying amount of the investment. Adjustments to
the carrying amount may also be necessary for a change in the investor‘s proportionate
interest in the investee arising from changes in the investee‘s other comprehensive
income. Such changes include those arising from the revaluation of property, plant and
equipment and from foreign exchange translation differences. The investor‘s share of
those changes is recognised in other comprehensive income of the investor (see IAS 1
Presentation of Financial Statements (as revised in 2007)). (IAS 28.11).
The entity‘s financial statements shall be prepared using uniform accounting policies for
like transactions and events in similar circumstances (IAS 28.26). If an associate or joint
venture uses accounting policies other than those of the entity for like transactions and
events in similar circumstances, adjustments shall be made to conform the associate‘s or
joint venture‘s accounting policies to those of the entity when the associate‘s financial
statements are used by the entity in applying the equity method (IAS 28.36).
Solvency II framework: When calculating the excess of assets over liabilities for related
undertakings, other than related insurance and reinsurance undertakings, the
participating undertaking shall value the related undertaking's assets and liabilities in
accordance with the equity method as prescribed in international accounting standards,
as endorsed by the Commission in accordance with Regulation (EC) No 1606/2002,
where valuation in accordance with Articles 75 to 86 of Directive 2009/138/EC is not
practicable. In such cases the value of goodwill and other intangible assets valued at zero
shall be deducted from the value of the related undertaking.
Solo treatment of participations (§SCR.14)
EIOPA-DOC-12/467 §14 discusses the identification of participations, their valuation, and
their treatment in the calculation of the SCR under Solvency II.
Identification of participations
The text quoted below defines how (re)insurers should assess whether a holding is classified
as a participation.
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SCR.14.2. Characteristics of a participation
SCR.14.3. A participation is constituted by share ownership or by the exertion of a
dominant or significant influence over another undertaking. The following paragraphs
describe how both types of participation can be identified.
SCR.14.4. The identification is based on an assessment from a solo perspective.
SCR.14.2.1 Participations by virtue of share ownership
SCR.14.5. When identifying a participation based on share ownership, directly or by way
of control, the participating undertaking has to identify
(i)
(ii)
its percentage holding of voting rights and whether this represents at least 20% of the
potential related undertaking‘s voting rights and
its percentage holding of all classes of share capital issued by the related undertaking and
whether this represents at least 20% of the potential related undertaking‘s issued share
capital.
Where the participating undertaking‘s holding represents at least 20% in either case its
investment should be treated as a participation.
SCR.14.6. Where the participation is in an insurance or reinsurance undertaking subject
to Solvency II, the assessments under SCR.14.4 (i) relate to paid-in ordinary share capital
referred to in OF.4 (i) and under SCR.14.4 (ii), to paid-in ordinary share capital referred to
in OF.4 (i) and paid-in preference shares.
SCR.14.2.2 Participations by virtue of the exertion of dominant or significant
influence
SCR.14.7. When identifying a participation… on the basis that the participating
undertaking can exert a dominant or significant influence over another undertaking, the
following factors have to be considered:
(i)
(ii)
(iii)
(iv)
(v)
(vi)
(vii)
current shareholdings and potential increases due to the holding of options, warrants or
similar instruments
representation on the administrative, management or supervisory board of the potential
related undertaking
involvement in policy-making processes, including decision making about dividends or
other distributions
material transactions between the participating undertaking and potential related
undertaking
interchange of managerial personnel
provision of essential technical information
membership of a mutual undertaking where that membership is sufficiently large to be
non-homogeneous when compared to that of other members
Identification of a participation in a financial and credit institution (F&CI)
The text quoted below defines how (re)insurers should assess whether a particular
participation is categorised as an F&CI participation. Additional information relating to this is
included in appendix 8.1.
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SCR.14.2.3. Participations in financial and credit institutions
SCR.14.8.Undertakings should treat a related undertaking as a financial and credit
institution, where it is an institution listed or described in accordance with Article 4(1) and
(5) of Directive 2006/48/EC or Article 4(1) of Directive 2004/39/EC. Any institution which
performs the functions or carries out the business described pursuant to those Articles
should be treated as a financial and credit institution notwithstanding that it may not be
subject to the Directives, either because it is a third country undertaking or otherwise out
of scope.
SCR.14.9. Any participation in a financial and credit institution held indirectly is treated in
the same way as a directly held participation in a financial and credit institution.
Identification of strategic participations
The text quoted below defines how (re)insurers should assess whether a particular
participation is categorised as a strategic participation.
SCR.14.2.4 Strategic participations
SCR.14.10. An equity investment is of a strategic nature if the following criteria are met:
(i)
(ii)
The value of the equity investment is likely to be materially less volatile for the following 12
months than the value of other equities over the same period as a result of both the nature
of the investment and the influence exercised by the participating undertaking in the
related undertaking.
the nature of the investment is strategic, taking into account all relevant factors, including:
(a) the existence of a clear decisive strategy to continue holding the participation for [a]
long period
(b) the consistency of the strategy referred to in point (a) with the main policies guiding or
limiting the actions of the undertaking
(c) the participating undertaking‘s ability to continue holding the participation in the related
undertaking
(d) the existence of a durable link
(e) where the insurance or reinsurance participating company is part of a group, the
consistency of such strategy with the main policies guiding or limiting the actions of
the group
Treatment of non-F&CI participations in the SCR / OF calculation
The text quoted below discusses the treatment of participations other than financial and
credit institutions under Solvency II.
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SCR.14.4. Treatment of participations, other than in financial and credit
institutions, in the calculation of the Solvency Capital Requirement with the
Standard Formula
SCR.14.12. The calculation of the Solvency Capital Requirement in accordance with the
standard formula for participations in undertakings other than financial and credit
institutions, does not require the aggregation of the investment in own funds items in
respect of each participation. The equity risk charge relevant to the investment in ordinary
or preference share capital of the related undertakings is determined independently from
the application of the relevant risk charges (e.g. interest, spread, concentration, currency)
to any investment in subordinated liabilities of the related undertaking, which is treated as
a bond.
SCR.14.13. When applying the standard formula to the equity and subordinated liability
components of a participation, the undertaking has to:
(i)
(ii)
(iii)
apply the interest and spread risk sub-modules set out in subsection SCR.5.5. and
SCR.5.9. relevant to bonds to holdings of subordinated liabilities
apply the relevant equity risk charges to equity holdings as set out in subsection SCR.5.6.
apply additional market risk sub-modules, such as currency, as appropriate
Note that the treatment of equity investments in a strategic participation differs from the
treatment of those in a non-strategic participation (¶SCR.5.40):
–
–
Equity investments in strategic participations have a stress of 22% applied to them. No
justification for or derivation of this figure could be found. A possible derivation is as 50% of the
average of the Type 1 and Type 2 stresses (cf. the CEIOPS minority opinion in section 5.2.1).
Equity investments in non-strategic participations have a standard Type 1 or Type 2 stress
applied to them. These are 39% and 49% (pre symmetric adjustment) respectively.
Treatment of F&CI participations in the SCR / OF calculation
The text quoted below discusses the treatment of participations that are financial and credit
institutions under Solvency II.
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SCR.14.4. Treatment of participations in financial and credit institutions in the
calculation of Own Funds
SCR.14.14. When calculating the value of a participation, in order to assess whether the
deductions set out in SCR.14.16 or SCR.14.17 apply, the undertaking has to consider
holdings of both equity and any other own-fund items held in the related undertaking by
the participating undertaking.
SCR.14.15. The deductions and other treatments in respect of financial and credit
institutions are set out in Annex V.
SCR.14.16. The basic own funds have to be reduced by the full value of each
participation in a financial and credit institution that exceeds 10% of items listed in OF.4.
SCR.14.17. The basic own funds have to be reduced by the part of the aggregate value
of all participations in financial and credit institutions, other than participations dealt with
under SCR.14.16., that exceeds 10% of items listed in points OF.4.
SCR.14.18. In calculating the 10% of items listed in OF.4. the amount of own-funds items
before any deduction set out in SCR.14.16. or SCR.14.17. is used.
SCR.14.19. Notwithstanding SCR.14.16. and SCR.14.17., there is no deduction for
strategic participations which are included in the calculation of the group solvency on the
basis of method 1 as described in subsection G.1.1.
SCR.14.20. Deductions according to SCR.14.17. are applied on a pro-rata basis to all
participations referred to in that paragraph.
SCR.14.21. Deductions included in paragraphs SCR.14.16. and SCR.14.17. are made
from the corresponding tier in which the participation has increased the own funds of the
related undertaking as follows:
(i)
(ii)
(iii)
holdings of Common Equity Tier 1 items of financial and credit institutions have to be
deducted from the items listed in OF.4.
holdings of Additional Tier 1 instruments of financial and credit institutions have to be
deducted from the items listed in OF.39.
holdings of Tier 2 instruments of financial and credit institutions have to be deducted from
the items listed in OF.40.
SCR.14.22. Where the items to be deducted are not classified into tiers, all deductions
are made from the amount of items listed in OF.4.
SCR.14.23. Where the amount of the deduction exceeds the amount from which it is
required to be deducted in accordance with SCR.14.21., the excess is deducted from
higher quality items until the deduction is made in full.
SCR.14.24. In the calculation of the Solvency Capital Requirements amounts not
deducted should be treated in accordance with subsection 14.6. when an internal model
is used and section SCR.5. when the standard formula is applied.
Treatment of participations under an internal model
The text quoted below discusses the treatment of participations where the (re)insurer uses
an internal model.
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SCR.14.5. Treatment of participations in the calculation of the Solvency Capital
Requirement with an internal model
SCR.14.25. The requirements set out in subsection SCR.14.5. apply to firms using
internal models in so far as any reduction of own funds set out in subsection SCR.14.5.
for holdings in financial and credit institutions has to be made. The treatment of holdings
in financial and credit institutions not deducted in whole or part has to ensure that the
requirements set out in Article 103 (3) of Directive 2009/138/EC are met.
Treatment of participations in the concentration risk module (§SCR.5.9)
The text quoted below relates to the treatment of participations in the concentration risk
module.
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SCR.5.105. The scope of the concentration risk sub-module extends to assets
considered in the equity, spread risk and property risk sub-modules, and excludes assets
covered by the counterparty default risk module in order to avoid any overlap between
both elements of the standard calculation of the SCR.
…
SCR.5.109. According to an economic approach, exposures which belong to the same
group as defined in Article 212 of the Solvency II Framework Directive or to the same
financial conglomerate as defined in Article 2(14) of the Financial Conglomerate Directive
(2002/87/EC) should not be treated as independent exposures. The legal entities of the
group or the conglomerate considered in the calculation of own funds should be treated
as one exposure in the calculation of the capital requirement.
…
SCR.5.116….assets considered in the concentration risk sub-module should not include:
2. exposures an insurance or reinsurance undertaking has to a counterparty which belongs to
the same group as the insurance or reinsurance undertaking, provided that the following
conditions are met:
(i) the counterparty is an insurance or reinsurance undertaking, an insurance holding
company, a mixed financial holding company or an ancillary services undertaking
which is subject to prudential requirements;
(ii) the counterparty is fully consolidated in the same consolidation scope as the
undertaking;
(iii) the counterparty is subject to the same risk evaluation, measurement and control
procedures as the undertaking;
(iv) the counterparty is established in the Union;
(v) there is no current or foreseen material practical or legal impediment to the prompt
transfer of own funds or repayment of liabilities from the counterparty to the
undertaking;
3. the value of the participations as defined in Article 92(2) of Directive 2009/138/EC in financial
and credit institutions that are deducted from own funds;
…
Special reference to participations
SCR.5.131. No capital requirement should apply for the purposes of this sub-module to
exposures of undertakings to a counterparty which belongs to the same group as defined
in Article 212 of Directive 2009/138/EC, provided that the following conditions are met:
–
–
–
the counterparty is an insurance or reinsurance undertaking or a financial holding company,
asset management company or ancillary services undertaking subject to appropriate
prudential requirements;
the counterparty is included in the same consolidation as the undertaking on a full basis;
there is no current or foreseen material practical or legal impediment to the prompt transfer of
own funds or repayment of liabilities from the counterparty to the undertaking.
Summary
In short:
1. For the valuation, a ―quoted market price in an active market‖ should be used. Where this is not
available the treatment depends on the type of undertaking:
o (Re)Insurers:
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
2.
3.
4.
5.
6.
The undertaking should be valued using the equity method on a Solvency II
consistent basis. Thus it is recognised at cost plus the attributable profits (less
losses), less any distributions. These profits (losses) should be as determined on
a Solvency II consistent basis. Furthermore, goodwill should not be recognised
so as to ensure Solvency II-consistency.
 Where the undertaking is not a subsidiary and it is not possible to value the
undertaking on a Solvency II consistent basis, it should be valued in a manner
consistent with the Solvency II treatment of assets.
o Other undertakings:
 The undertaking should be valued using the equity method on a Solvency II
consistent basis. Thus it is recognised at cost plus the attributable profits (less
losses), less any distributions. These profits (losses) should be as determined on
a Solvency II consistent basis. Furthermore, goodwill should not be recognised
so as to ensure Solvency II-consistency.
 Where this is not practicable, the equity method applied to the IFRS balance
sheet modified for goodwill and other intangible assets should be used to value
the undertaking.
 Where the above are not possible and the undertaking is not a subsidiary, it
should be valued in a manner consistent with the Solvency II treatment of assets.
There are two ways in which a related undertaking may be classified as a participation:
o ―By virtue of share ownership‖, and
o ―By virtue of the exertion of dominant or significant influence‖.
o A related undertaking is a participation by virtue of share ownership if the (re)insurer
holds at least 20% of the potential voting rights or if the (re)insurer holds at least 20% of
the undertaking‘s issued share capital.
o For Solvency II-regulated entities, the assessment of voting rights held considers only
paid-in ordinary share capital (and not preference shares), i.e. only ordinary shares
included in tier one. The assessment of share capital held includes paid-in preference
shares, however.
Strategic participations are classified as such on the basis of lower volatility of the investment and
the strategic nature of the investment (plan to hold for a long period, ability to hold for that period,
etc.). No justification for or derivation of the 22% stress is provided, although it may relate to a
minority opinion expressed in CEIOPS-DOC-63/10.
Treatment of non-F&CI participations in the SCR standard formula is captured through the market
risk module, i.e.:
o The application of the equity charge on the ordinary and preference share capital held;
o The application of the interest and spread charges to liabilities held; and
o The application of any remaining relevant market risk charges.
Treatment of FC&I participations:
o Where a participation constitutes more than 10% of the (re)insurer‘s tier one own funds,
the full value of that participation is removed from the (re)insurer‘s basic own funds.
o Where any remaining F&CI participations exceed the 10% threshold in aggregate, the
excess over that threshold is removed from the (re)insurer‘s basic own funds. This is
done on a pro-rata basis.
o There are requirements as to the tiers from which the above deductions are made.
o Amounts not deducted should be treated in line with the market risk module of the
standard formula or the internal model of the (re)insurer, whichever is appropriate.
o The above attempts to ensure consistency between the treatment of banks under
Solvency II and (re)insurers under Basel III (see ¶80–89 of the revised Basel III capital
requirements proposal). There are some differences, however. The Basel III
specifications are therefore discussed in section 5.2.4.
o It should be noted that the treatment of F&CI participations proposed by EIOPA leads to a
discontinuity where the participation exceeds 10% of tier one own funds. A small increase
in the value of the participation (say from 9% to 11%) can result in a significant reduction
in the (re)insurer‘s tier one own funds.
Treatment of participations in the concentration risk module:
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o
o
o
5.2.4
The concentration risk module is only applied to assets included in the equity, spread,
and property risk sub-modules. It is not applied to instruments included in the
counterparty default risk module.
In assessing the value of total assets against which holdings are assessed to determine
whether they represent concentrations (i.e. the divisor), exposures to the following are
excluded:
 counterparties in the same group as the (re)insurer, provided certain conditions
are met; and
 the value of F&CI participations deducted from own funds.
Furthermore, no concentration risk capital requirement is calculated for counterparties
within the same group provided certain conditions are met.
Basel III treatment of investments in banking, financial and insurance entities
The relevant document is the Basel III capital requirements specification ―Basel III: A global
regulatory framework for more resilient banks and banking systems‖, available at:
http://www.bis.org/publ/bcbs189.htm.
The relevant paragraphs are 80 to 89, which deal with ―investments in the capital of banking,
financial and insurance entities that are outside the scope of regulatory consolidation‖.
–
–
¶80–83 consider the case where the bank ―does not own more than 10% of the issued share
capital of the entity‖.
o ¶80 specifies what investments are considered in the section. In addition to common
shares the following are affected:
 ―direct, indirect and synthetic holdings of capital instruments‖, where
 ―capital‖ includes ―common stock and all other types of cash and synthetic capital
instruments (eg subordinated debt)‖.
o ¶81 specifies that:
 ―If the total of all holdings listed [in ¶80] above in aggregate exceed 10% of the
bank‘s common equity (after applying all other regulatory adjustments in full listed
prior to this one) then the amount above 10% is required to be deducted,
applying a corresponding deduction approach. This means the deduction should
be applied to the same component of capital for which the capital would qualify if
it was issued by the bank itself.‖
o ¶82 specifies that, where the bank does not have sufficient assets at a particular tier to
perform that tier‘s deduction in full, then the difference must be deducted from the tier of
capital immediately senior to that tier.
o ¶83 specifies that amounts that are not deducted are still subject to risk weighting (i.e.
capital requirement calculations).
¶84–87 consider ―significant investments‖.
o ¶84 corresponds to ¶80, except that it considers the case where the bank owns more
than 10% of the entity‘s common shares or the entity is an ―affiliate of the bank‖.
o ¶85 specifies that, with the exception of ―common shares‖, investments considered in ¶84
are fully deducted from the relevant tier of capital (similar to ¶81).
o ¶86 and ¶87 state that investments in common shares considered in ¶84 ―receive limited
recognition… capped at 10% of the bank‘s common equity (after the application of all
regulatory adjustments set out in paragraphs 67 to 85)‖.
In summary and in contrast to section 5.2.3:
–
–
In both cases, a company is recognised as a ―participation‖ when the participating company owns
in excess of proportion p of the common shares. Basel III defines p as 10%; EIOPA-DOC-12/467
defines p as 20%.
Similarly, both Basel III and EIOPA-DOC-12/467 apply restrictions to the extent to which
participations in other financial entities can be recognised to back the capital requirement. These
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–
–
–
–
restrictions relate to a threshold proportion of t of available capital (own funds). Both define t at
10%, but the details of the way in which t is used differ.
¶80–83 of Basel III consider all investments. ¶84–87 consider participations specifically. EIOPADOC-12/467 considers only participations.
Under Basel III, where the total investment in capital instruments of entities under ¶80–83 (which
individually are not participations) exceeds t (10%) of the bank‘s assets available to back its
capital requirement, the investments are reduced to 10%.
o This presumably excludes standard debt instruments issued by the entity, since these
would not be included in that entity‘s available capital. Subordinated debt is included.
o There is no similar requirement in EIOPA-DOC-12/467.
o This is a deduction from available capital. ¶83 specifies that any amounts not deducted
from available capital still attract a capital requirement.
Basel III requires that where a bank holds more than p (10%) of the common shares of an entity
or the entity is an affiliate (i.e. a participation):
o All investments in instruments backing that entity‘s capital requirement other than in its
common equity are held at nil, and are deducted from the corresponding tier of capital of
the bank (¶85).
o The amount of the holdings in the entity‘s common equity recognised in the bank‘s
available capital is limited to t (10%) of the bank‘s common equity. ¶89 specifies a risk
weighting of 250% for those amounts not deducted. (This compares to a risk weighting of
300% for publicly traded equity exposures, as per Docket ID OCC-2012-0009 issued by
the US Treasury, Federal Reserve, and Federal Deposit Insurance Corporation.)
Presumably those amounts deducted do not attract a capital requirement (i.e. do not
contribute to Risk Weighted Assets). This 10% threshold is applied in aggregate.
o This contrasts with EIOPA-DOC-12/467, where:
 Where the value of an F&CI participation exceeds t (10%) of own funds, its value
is set to nil. This includes investments in the participation‘s common equity.
 Where the aggregate value of the remaining F&CI participations exceeds t (10%)
of own funds, their values are reduced on a prorated basis so that the aggregate
equals 10%.
o EIOPA-DOC-12/467 is therefore less onerous than Basel III in its treatment of
investments in instruments backing the participation‘s capital requirement other than its
common equity, since they are not necessarily held at nil.
o EIOPA-DOC-12/467 is more onerous in its treatment of common equity, however, since
where the threshold t (10%) is breached the value of the shares is deducted in full.
Basel III only reduces the value to the threshold t (10%).
Although Basel III and EIOPA-DOC-12/467 calculate deductions differently, the application of
those deductions to the tiers of available capital is similar.
o The instruments under consideration are available to back the participation‘s capital
requirement, i.e. they form the capital funding of the participation. They therefore affect
the tiering of the participation‘s available capital.
o Suppose the instrument contributes towards tier X_sub of the participation‘s available
capital (own funds). Any deductions relating to that instrument are taken from tier X_hold
of the participating company‘s available capital. X_hold is set equal to X_sub.
o Where X_sub is not defined, the deduction must be taken from the highest tier.
o Where the total deductions from X_hold exceed X_hold, any excess must be deducted
from the next-highest tier.
5.3 Other relevant jurisdictions (e.g. OSFI, APRA)
The Australian Prudential Regulatory Authority (APRA) developed Prudential Standard
GPS 112, titled ―Capital Adequacy: Measurement of Capital‖. This Prudential Standard sets
out the essential characteristics that an instrument must have to qualify as Tier 1 or Tier 2
capital for inclusion in the capital base for assessing capital adequacy. The version
referenced became effective on 1 January 2013. Some sections specific to participations are
reproduced below. Similar sections exist in Prudential Standard LPS 112, the life companyspecific standard.
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From the Capital Base section:
14. APRA may, in writing, require an insurer to:
(a) exclude from its capital base any component of capital that APRA has reasonable
grounds to believe does not represent a genuine contribution to the financial strength of
the insurer; or
(b) reallocate to a lower category of capital a component of capital where APRA has
reasonable grounds to believe that it does not fully satisfy the requirements of this
Prudential Standard for the category to which it was allocated by the insurer.
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From Attachment B (Regulatory adjustments)
Regulatory adjustments to Common Equity Tier 1 Capital
Goodwill and other intangibles
12. Subject to paragraph 13 of this Attachment, a regulated institution must deduct the
following items net of any associated deferred tax liability that would be extinguished if the
assets involved become impaired or derecognised under Australian Accounting
Standards:
(a) goodwill and any other intangible assets arising from an acquisition, net of adjustments to
profit or loss reflecting any changes arising from ‗impairment‘ of goodwill; and
(b) other intangible assets net of adjustments to profit or loss reflecting amortisation and
impairment. Intangible assets are as defined in Australian Accounting Standards and
include capitalised expenses and capitalised transaction costs. These expenses include:
(i) costs associated with debt raisings and other similar transaction-related costs that
are capitalised as an asset;
(ii) costs associated with issuing capital instruments if not already charged to profit
and loss;
(iii) capitalised information technology software costs; and
(iv) other capitalised expenses including capitalised expenses of a general nature such
as strategic business development initiatives. These include, in addition to the
above listed items, other forms of transaction costs and like costs that are required
to be deferred/capitalised and amortised as part of the measurement of assets and
liabilities under Australian Accounting Standards.
13. An investment in a subsidiary, joint venture or associate that:
(a)
(b)
(c)
(d)
is operationally independent;
represents a genuine arm‘s-length investment;
is not subject to prudential capital requirements; and
does not undertake insurance business or business related to insurance business
does not have its intangible assets (including the intangible component that could arise
after or outside of acquisition) deducted under paragraph 12 of this Attachment.
Investments in subsidiaries, joint ventures and associates
18. A regulated institution must make a deduction for investments in subsidiaries, joint
ventures and associates that are subject to regulatory capital requirements. The amount of
the deduction is the lesser of the regulated institution‘s share of the regulatory capital
requirements and the value of the investment that is recorded on the regulated institution‘s
balance sheet after adjustment for any intangible component in accordance with
paragraphs 12 and 13 of this Attachment. This deduction must be applied after any
deduction for intangibles in the investment in accordance with paragraphs 12 and 13 of
this Attachment.
19. For the purposes of the deduction in paragraph 18 of this Attachment, the regulatory
capital requirement of the investment is:
(a) the prescribed capital amount if the investment is in an insurer as defined under the Act; or
(b) the equivalent amount to the prescribed capital amount if the investment is an entity
carrying on insurance business in a foreign jurisdiction; or
(c) a comparable regulatory capital requirement as agreed with APRA.
Unless agreed otherwise with APRA, the regulatory capital requirement must be the
amount determined at the reporting date or within a period of three months prior to the
reporting date.
20. If the investment subject to the deduction in paragraph 18 of this Attachment is a nonPage 23 of 77
operating holding company (NOHC), the regulated institution must ‗look-through‘ the
investment to the value and regulatory capital requirements of the entity/entities owned by
the NOHC.
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Discussion Document 53 (v 10) – Treatment of participations in the solo entity submission under SAM
From Attachment I (Level 2 Insurance Groups)
Regulatory adjustments to Common Equity Tier 1 Capital
11. In addition to the regulatory adjustments to Common Equity Tier 1 Capital in
Attachment B, a Level 2 insurance group must deduct from Common Equity Tier 1
Capital:
(b) equity exposures and other capital investments in non-consolidated subsidiaries or
controlled entities, whether regulated or unregulated, subject to the materiality of the
controlled entity (to be determined in consultation with APRA). This deduction does not
apply to a controlled entity, where it acts as a holding company for pass-through of equity
exposures and other capital investments in Level 1 insurers or equivalent overseas
entities carrying on insurance business. In the event that a controlled entity holds equity
exposures and other capital investments in controlled entities not eligible for
consolidation, the Level 2 insurance group must deduct its equity exposures and other
capital investments in the holding company net of the value of the holding company‘s
investment in any Level 1 insurer or equivalent overseas entities carrying on insurance
business; and
(c) goodwill and any other intangible component of the investments in nonconsolidated
subsidiaries (to the extent these have not been deducted under sub-paragraph (b)).
12. The deductions relating to investments in subsidiaries, joint ventures and associates
(refer to Attachment B) do not apply to investments in subsidiaries of Level 2 insurance
groups. Investments in subsidiaries are treated as either consolidated subsidiaries and as
a result treated as part of the Level 2 insurance group or as non-consolidated
subsidiaries.
15. APRA may require a Level 2 insurance group to deduct from Common Equity Tier 1
Capital an amount to cover undercapitalisation of a non-consolidated subsidiary (or
subsidiaries)…
APRA also developed ―Prudential Standard GPS 114: Capital Adequacy: Asset Risk
Charge‖. This standard discusses the way in which the capital requirement in respect of
asset risks is calculated. The paragraph relevant to subsidiaries is quoted below:
Assets and liabilities to be stressed
17. The following assets and liabilities must not be stressed:
(a) assets whose value must be deducted from the capital base (e.g. goodwill in
subsidiaries) in GPS 112; and
Finally, the LPS114 (discussing the asset risk charge for life insurers) includes an
attachment C discussing Extended Licensed Entities (ELEs). These are SPVs or other
related entities where assets are held off-balance sheet. Life insurers may seek approval to
calculate the asset risk charge on a look-through basis (to the underlying assets and
liabilities) for ELEs.
In summary:
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–
–
–
The value assigned to a subsidiary is dependent on its nature:
o Operationally-independent subsidiaries not subject to prudential capital requirements that
do not undertake business related to insurance (and which represent an arm‘s-length
investment) are valued including goodwill (GPS112 attachment B ¶13).
o Subsidiaries not meeting those requirements are valued excluding goodwill (GPS112
attachment B ¶13).
o Where a subsidiary is subject to regulatory capital requirements, a deduction equal to its
regulatory capital requirement must be made (GPS112 attachment B ¶18).
For ―Level 2 Insurance Groups‖ the treatment is somewhat different. Subsidiaries are split
between consolidated (which are included in the group) or non-consolidated (which are not). Any
undercapitalisation of a non-consolidated subsidiary may result in an additional deduction from
Common Equity Tier 1 (GPS112 attachment I ¶11–12,15).
No asset risk charge is applied to the value of any assets deducted from the ―Capital Base‖ (i.e.
the available capital). (GPS114 ¶17).
The Office of the Superintendent of Financial Institutions Canada (OSFI) developed the
Minimum Continuing Capital and Surplus Requirements (MCCSR) for Life Insurance
Companies. The version referenced was effective 1 January 2013. Some sections specific
to participations are reproduced below. Regulations relating to non-life insurance companies
were not available.
From Chapter 1, “Overview and General Requirements”
1.1. Overview
1.1.1. Definition of capital
The definition of capital comprises two tiers, tier 1 (core capital) and tier 2
(supplementary capital), and involves certain deductions, limits and restrictions. The
definition encompasses available capital within all subsidiaries that are consolidated for
the purpose of calculating the capital requirement.
1.1.2. Capital requirements
The capital requirement is determined on a consolidated basis. The consolidated entity
includes all subsidiaries (whether held directly or indirectly) that carry on a business that
a company could carry on directly (e.g., life insurance, real estate and ancillary business
subsidiaries).
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From Chapter 2, “Definition of Capital”
2.6 Goodwill and intangible assets
Unamortized goodwill will be deducted in the determination of net tier 1 capital. This
deduction comprises goodwill related to consolidated subsidiaries and goodwill related to
subsidiaries deconsolidated for MCCSR purposes. Goodwill related to substantial
investments in unconsolidated entities that is not otherwise deducted for MCCSR
purposes represents a diminution in the quality of tier 1 capital and will be subject to
supervisory scrutiny in the assessment of the strength of capital against the supervisory
target ratio. Companies will not be required to report goodwill related to substantial
investments on a regular basis, but must be able to produce this information if requested
by OSFI.
Additionally, the carrying value, net of amortization, of identified intangible assets that is
in excess of 5% of gross tier 1 capital will be deducted in the determination of net tier 1
capital. The deduction for intangible assets applies to identified intangible assets
purchased directly, or acquired in conjunction with or arising from the acquisition of a
business. Such intangibles may include, but are not limited to, trade names, customer
relationships, and policy and other distribution channels. Identified intangible assets
include those related to consolidated subsidiaries and subsidiaries deconsolidated for
MCCSR purposes.
2.9. Non-life financial corporation controlled by the company
Equity investments in non-life solvency regulated financial corporations that are
controlled (as defined in the Act) by the company will be deducted from capital. Non-life
solvency regulated financial corporations include those entities that are engaged in the
business of banking, trust and loan business, property and casualty insurance business,
the business of co-operative credit societies or that are primarily engaged in the business
of dealing in securities, including portfolio management and investment counselling. Fifty
percent of the net equity investment will be deducted from tier 1 capital, and an additional
fifty percent will be deducted from tier 2 capital. The deduction should be net of both:
–
–
goodwill and identified intangibles related to the investment that have been deducted from tier
1 capital per section 2.6, and
all amounts related to the investment representing components of accumulated other
comprehensive income that are ineligible for inclusion in MCCSR available capital.
Where the company has investments in preferred shares or debt instruments of the
corporation, the amount invested in these instruments will also be deducted from capital
if they qualify as capital by the regulator in that corporation's home jurisdiction. Further,
where a facility such as a letter of credit or guarantee is provided by the company, is
treated as capital by the non-life financial corporation controlled by the company, being
available for drawdown in the event of impairment of the corporation's capital and is
subordinated to the corporation's customer obligations, the full amount of the facility will
also be deducted from capital. Although the facility has not been called upon, if it were
drawn, the resources would not be available to cover capital requirements in the life
company.
No asset default factor will be applied to equity investments, letters of credit and
guarantees or other facilities provided to controlled non-life financial corporations where
these have been deducted from capital.
Investment in preferred shares or debt instruments of, or letters of credit provided to,
controlled non-life financial corporations that are not deducted from capital will be treated
like any other asset in accordance with this guideline (reference chapter 3).
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If a company guarantees the obligations of a controlled non-life financial corporation, an
off-balance sheet capital requirement will also be imposed (reference chapter 7).
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2.10. Substantial investments without control
Ownership interests in an entity including a joint venture, other than an eligible mutual
fund entity as described below, in which the company has made a substantial
investment (as defined in Section 10 of the Act) but does not control will be deducted
from capital. Fifty percent of the investments will be deducted from tier 1 capital, and an
additional fifty percent will be deducted from tier 2 capital. Canadian companies should
calculate the deduction net of all amounts related to the investment representing
components of accumulated other comprehensive income that are ineligible for inclusion
in MCCSR available capital.
Portfolio investments, defined as investments of between 10% and 30% in the common
shares of a corporation, that are subject to section 513 of the Insurance Companies Act,
will be grandfathered. However, the grandfathering provision will not apply to equity
investments in which the company, together with any of its subsidiaries and/or other
financial institutions affiliated with the company, hold more than 30% of the common
shares of another corporation.
Where a company has not been permitted to have a controlling interest in a foreign life
entity due to restrictions imposed in the foreign jurisdiction, the company will be
permitted to consolidate based on its proportionate equity interest of that entity.
However, excess capital in the foreign life entity can only be counted by the company if
confirmation that the excess capital is repatriable to the parent is provided by the
regulator in that jurisdiction. Further, excess capital that is counted must reflect any
income tax effect upon repatriation.
Where the company has investments in preferred shares or debt instruments of a
foreign life entity, the amount invested in these instruments will also be deducted from
capital if the instruments qualify as capital by the regulator in the home jurisdiction of the
entity. Further, where a facility such as a letter of credit or guarantee is provided by the
company and is treated as capital by the entity being available for drawdown in the
event of impairment of the entity's capital and is subordinated to the entity's customer
obligations, the full amount of the facility will be deducted from capital. Although the
facility has not been called upon, if it were drawn, these resources would not be
available to cover capital requirements in the life company.
No asset default factor will be applied to facilities that are deducted from capital.
Investments in preferred shares, debt instruments, and facilities that are not deducted
from capital will be treated like any other asset in accordance with this guideline
(reference chapter 3).
If a company guarantees the obligations of an entity it does not control, but in which it
has a substantial investment and has deducted it from capital, an off-balance sheet
capital requirement will also be imposed (reference chapter 7).
Companies are not required to deduct from capital substantial investments in mutual
fund entities that do not leverage their equity by borrowing in debt markets, and that do
not otherwise leverage their investments. Instead, a capital charge on the assets of the
mutual fund entity will apply based on the requirements of section 3.1.9. For example,
no deduction need be made from capital where the company makes a substantial
investment in a mutual fund as part of a structured transaction that passes through the
unaltered returns (i.e., no guarantee of performance) on the substantial investment to
the mutual fund holder.
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In summary:
–
–
The MCCSR is based on a consolidated approach (sections 1.1.1 and 1.1.2). As such, any life
subsidiaries are consolidated for the purposes of calculating the reporting company‘s available
capital and capital requirement.
The OSFI requires deductions in respect of both ―non-life financial corporations‖ that are
controlled (as per a legal definition) as well as corporations in which the (re)insurer ―has made a
substantial investment‖ (as per a legal definition). This includes short-term insurance companies.
o The full amount of any equity investments is deducted. 50% of the deduction is from the
participating (re)insurer‘s tier 1 capital; 50% from tier 2.
o Furthermore, any investments other than the equity considered above that qualify to back
the issuing corporation‘s capital requirements is also deducted.
o None of the assets deducted above are included in the asset default calculations (i.e.
market risk capital requirement).
5.4 Mapping of differences between above approaches (Level 2 and 3)
Although the above approaches (Solvency II Level 1 text, CEIOPS‘/EIOPA‘s advice,
Basel III, APRA and OSFI) are broadly consistent with each other and in line with the IAIS
principles, there are a number of key differences in the details:
–
–
–
For financial and credit institutions (F&CIs):
o CEIOPS‘ initial advice (see section 5.2.2) deducts the full value of F&CIs from own funds.
o EIOPA-DOC-12/467 (see section 5.2.3) applies an algorithm to determine a deduction
from own funds. Any participations exceeding a 10% threshold of own funds are deducted
in full, and any remaining participations are capped at 10% of own funds in aggregate.
o Basel III (see section 5.2.4) applies restrictions to both participations and nonparticipations in F&CIs. The restrictions to participations are such that F&CI participations‘
ordinary shares cannot contribute more than 10% (in aggregate) of the owner‘s available
capital. Any other qualifying capital instruments (e.g. subordinated debt) are held at nil in
the owner‘s available capital.
o APRA (see section 5.3) deducts any goodwill associated with the F&CI participation, as
well as the owner‘s share of that participation‘s regulatory capital requirement, from the
owner‘s available capital. The remaining value is stressed under the equivalent of the
market risk module.
o OSFI (see section 5.3) deducts in full any equity (and any other instruments contributing
towards the issuer‘s available capital) held in F&CI participations. This deduction is split
evenly between the owner‘s tier 1 and tier 2 capital. The instruments deducted are not
considered under the equivalent of the market risk module.
For (re)insurers:
o CEIOPS‘ initial advice includes (re)insurance participations at a value that excludes the
participation‘s own funds needed to back SCR and its goodwill.
o EIOPA-DOC-12/467 does not consider (re)insurance participations separately, including
them in the relevant market risk modules. Strategic participations receive a reduced
capital charge.
o Basel III treats (re)insurance participations in a similar manner to F&CI participations.
o APRA deducts any goodwill associated with the participation, as well as the owner‘s
share of that participation‘s regulatory capital requirement, from the owner‘s available
capital. The remaining value is stressed under the equivalent of the market risk module.
o OSFI requires life insurance companies to consolidate life insurance participations in
determining their available and required capital. Life insurance companies deduct non-life
insurance participations from the owner‘s available capital, however (split evenly between
tier 1 and tier 2). The instruments deducted are not considered under the equivalent of
the market risk module.
For other participations:
o CEIOPS‘ initial advice treats these as normal equity investments.
o EIOPA-DOC-12/467 includes any investments in other participations in the relevant
market risk modules. Strategic participations receive a reduced capital charge.
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o
o
APRA allows the owner to include the goodwill associated with a participation under
certain conditions. The investment is considered under the equivalent of the market risk
module.
OSFI requires some non-financial participations to be deducted in full from available
capital (split evenly between tier 1 and tier 2). The instruments deducted are not
considered under the equivalent of the market risk module.
6. ASSESSMENT OF AVAILABLE APPROACHES GIVEN THE SOUTH AFRICAN
CONTEXT
6.1 Introduction
This discussion document will consider the following issues:
1. The definition of participations;
2. The valuation of participations;
3. The treatment of the following categories of participation in the solo entity calculation regarding
the calculation of their value (and hence contribution to own funds) and of their risk (and hence
their contribution to the SCR):
o financial and credit institutions,
o (re)insurance participations,
o financial non-regulated participations, and
o non-financial non-regulated participations;
4. Where appropriate, any differences between local and foreign cases of the above;
5. If strategic participations are to be treated differently from non-strategic participations, then the
way in which their treatment should differ and if necessary the definition of a strategic
participation; and
6. The application of the concentration risk module.
Where appropriate, within each of these four subsections are considered:
1.
2.
3.
4.
Discussion of inherent advantages and disadvantages of each approach.
Impact of the approaches on EU 3rd country equivalence.
Comparison of the approaches with the prevailing legislative framework.
Conclusions on preferred approach.
Sections 6.3 to 6.9 below primarily consider the treatment of equity investments in various
classes of participation. Investments in non-equity instruments issued by participations, e.g.
bonds, are not included because they are fixed obligations and less risky. These should be
considered under the relevant market risk modules (e.g. interest rate, credit spread).
Where the type of instrument is not clear (e.g. hybrid instruments), the general criterion to
apply is as follows: ―If the instrument were not issued by a participation, would it be
considered in the equity risk module?‖:
–
–
If it would not, then unless specifically discussed below it should be considered under the relevant
market risk module(s) and the discussions below do not apply to it.
If it would, then the instrument should be treated as discussed in the sections below.
6.2 Definition of a participation
The working group was comfortable with the current Solvency II definition of a participation.
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Some confusion existed regarding the classification of unit trusts, however. Under IFRS, unit
trusts in which a company holds a significant portion of the units are consolidated as
subsidiaries. This is not appropriate in a SAM context. The definition of a participation should
explicitly exclude the case in which a (re)insurer holds a significant portion of a unit trust‘s
units (as opposed to the management company itself). In that case the standard lookthrough approach should be applied. This is in line with SAM position paper 39 §4.2.7.
6.3 Principles of valuation for all participations
6.3.1
Discussion of inherent advantages and disadvantages of each approach
SAM position paper 39 (―Assets and liabilities other than technical provisions‖) recommends
the following for the valuation of participations (§4.2.7):
–
All participations are valued at economic / fair value, whether this is determined using a mark-tomarket or mark-to-model approach.
Practically, the above is given by the:
1. observed market value in a deep and liquid market; or, where this is not available, a
2. market-consistent mark-to-model value based on IFRS fair value principles.
Using fair value means the valuation of participations at a solo entity level differs from that at
a group level. Participations are valued at own funds in the group calculation, ignoring any
write-up to fair value. The treatment of risks in participations in the solo entity calculation
should therefore correspond to the fair value, i.e. allow for all risks in the asset valuation.
In order to ensure consistency between listed and unlisted participations, additional
disclosures may be required regarding the methodology used to derive mark-to-model fair
values. The relevant SAM task group should consider this and specify an appropriate
recommendation.
Note that the above is inconsistent with the valuation of participations in EIOPA-DOC-12/467
¶V.8 (see section 5.2.3). That specifies the following hierarchy:
1. ―quoted market price in an active market‖,
2. ―valued with the equity method based on a Solvency II consistent recognition and measurement
for the subsidiary‘s balance sheet‖, and
3. valued according to generic Solvency II asset valuation requirements.
The application of the second of these would lead to a value different from the fair value of
the participation. It was therefore in contradiction to SAM position paper 39 and hence was
not considered further.
6.3.2
Impact of the approaches on EU 3rd country equivalence
The proposed deviation from the Solvency II hierarchy was not felt to jeopardise thirdcountry equivalence. This is because the proposal uses fair value for the valuation of
participations and hence is market-consistent.
6.3.3
Comparison of the approaches with the prevailing legislative framework
The current legislation allows participations in financial institutions to be included in the
capital resources at net asset value less the institution‘s capital requirements; for nonPage 30 of 77
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financial institutions the greater of net asset value and fair value, as defined by accounting
standards, can be included.
This deviates from using the fair value for financial participations. However, the risk captured
in the current legislation through reducing the value of the asset will be captured elsewhere
under SAM. See the sections below.
6.3.4
Conclusions on preferred approach
The recommendation for the valuation of participations in the solo entity calculation is to use
the market value or fair value determined using IFRS fair value principles. This is in line with
SAM position paper 39, section §4.2.7, as well as the general principles of market
consistency.
6.4 Treatment of financial and credit institutions (F&CI) in own funds and the SCR
6.4.1
Discussion of inherent advantages and disadvantages of each approach
The following possible approaches present themselves based on the ICP, Solvency II,
CEIOPS/EIOPA, Basel III, APRA, and OSFI documentation discussed above:
1. Exclude the full value of F&CI participations from the own funds and apply a nil capital charge
(consistent with SA QIS1 and SA QIS2).
2. Include the full value of the F&CI participation, but modify the SCR appropriately (e.g. through the
application of a 100% stress).
3. Apply a methodology consistent with Basel III (which will be similar to EIOPA-DOC-12/467 §14),
limiting the extent to which F&CI participations can be recognised in own funds.
Each of the above has a variety of strengths and weaknesses, which may be mitigated
through the modification of the methodology.
The advantages of approach 1 include:
–
–
–
–
The application is simple.
It is relatively prudent, meaning that its use is unlikely to jeopardise third-country equivalence for
Solvency II.
It helps to mitigate the risk of contagion within a group (specifically between the insurance and
banking sectors), which is an objective of the CEIOPS/EIOPA recommendations.
It avoids the double-gearing of participations‘ capital.
The disadvantages of approach 1 include:
–
–
It is conservative relative to Basel III, thus potentially creating a non-level playing field for financial
groups with different corporate structures.
It does not recognise that some exposure may be attributable to policyholders.
The advantage of approach 2 is:
–
It recognises that some exposure to F&CI participations may be attributable to policyholders.
The disadvantages of approach 2 include:
–
It is less conservative than Basel III and the EIOPA specifications as the resultant capital
requirement will be diversified with other risk types. It therefore:
o potentially creates a non-level playing field for financial groups with different corporate
structures; and
o may jeopardise third-country equivalence with Solvency II.
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The advantages of approach 3 include:
–
–
–
It is consistent with Basel III, thus creating a level playing field for financial groups with different
corporate structures.
It helps to mitigate the risk of contagion within a group (specifically between the insurance and
banking sectors), which is an objective of the CEIOPS/EIOPA recommendations.
It avoids the double-gearing of participations‘ capital where those participations are significant
contributors to the participating (re)insurer‘s own funds.
The disadvantages of approach 3 include:
–
–
It does not recognise that some exposure may be attributable to policyholders.
While the application of the methodology to own funds may not be difficult, its application in the
SCR calculation may be. This is because F&CI participations may need to be partially excluded
from the market risk module.
o This could be mitigated by allowing (re)insurers for which this condition is met to reduce
to zero the contribution to own funds of those participations and hence avoid partially
stressing those participations. Regulatory approval would be required to introduce this
conservatism.
An adjustment to allow for the potential exposure attributable to policyholders could be
made. Rather than deducting the full value of the F&CI participation from own funds, only the
shareholder exposure could be deducted. This is determined by calculating the change in
the (re)insurer‘s basic own funds (BOF) following a 100% stress to that F&CI participation‘s
shares (―delta-BOF approach‖). This will increase the complexity of the own funds
calculation. However, should a (re)insurer consider policyholders‘ exposure to be negligible,
then the full amount could be deducted. Regulatory approval would be required to introduce
this conservatism.
It should be noted that approach 3 applies a 100% stress to non-equity holdings in F&CI
participations which are counted towards the participations‘ available capital, e.g.
subordinated bonds. See ¶84 and 85 in section 5.2.4.
All of the above overstate the contribution to economic available assets where the F&CI
participation does not meet its capital requirements. In this case an additional deduction from
own funds may be appropriate.
In order to mitigate the risk of regulatory arbitrage through corporate structuring as well as
the risk of financial contagion, any limits to the eligibility of investments in F&CI participations
should be applied at a total level and not per participation.
In order to mitigate the disadvantages of the Basel III approach, the following adjustments
could be implemented:
–
The total holdings in F&CI participations‘ ordinary equity should be compared to the 10%
threshold.
o Where the threshold is not breached no additional action is required beyond stressing the
holdings under the equity risk module.
o Where the threshold is breached, say by x percentage points so that the total holdings
equal x%+10%, this excess must be deducted using the delta-BOF approach. The equity
not deducted should be stressed under the equity risk module. Thus:
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
The holdings in F&CI participations are reduced by factor f and the liabilities
recalculated. The corresponding change in BOF under this scenario is deducted
from tier 1 own funds. f is set such that the excess x% is removed:
f 
x%
.
x%  10%

–
The stress applied in the equity risk module is only applied to the holdings in the
F&CI participations remaining after the deduction from tier 1 own funds. So,
where the deduction equals y% of holdings in F&CI participations, the stress in
the equity risk module is only applied to (100–y)% of those holdings.
 Note that y will equal f if the liabilities are not sensitive to changes in the value of
F&CI participations.
o Where this is felt to be disproportionately complex for the risk, the (re)insurer may apply
not to recalculate the liabilities under the reduction in holdings. This will result in a
deduction to own funds of f % of F&CI holdings.
o Note that the holdings will remain above 10% of own funds given the above for the
following reasons:
 the actual deduction is calculated using a delta-BOF approach, and
 the factor f is calculated with respect to the pre-deduction own funds.
Although this deviates from Basel III, it is consistent with the treatment in EIOPA-DOC12/467 §14.
The deduction for instruments available to back a F&CI‘s capital requirement other than its
ordinary equity (e.g. preference shares, qualifying subordinated bonds) should also be calculated
using a delta-BOF approach. Where this is felt to be disproportionately complex for the risk, the
(re)insurer may apply to the regulator to deduct the full value of the instruments. In order not to
double-count risk, these instruments should not be stressed in the SCR calculation.
Two separate views existed within the working group:
–
–
View 1:
o The treatment of F&CI participations should be as above, namely the modified Basel III
approach.
View 2:
o The treatment of F&CI participations should correspond exactly to the treatment under
Solvency II and hence EIOPA-DOC-12/467.
6.4.2
Impact of the approaches on EU 3rd country equivalence
Any proposed treatment of F&CI participations that is significantly less onerous than that
adopted by Solvency II may jeopardise third country equivalence. Although the final
treatment is not known, EIOPA-DOC-12/467 provides the current position. Since it does not
entirely exclude all F&CI participations from own funds, some level of inclusion is likely to be
appropriate.
Given the similarity of EIOPA-DOC-12/467 with the Basel III approach, an approach based
on Basel III is unlikely to be insufficiently onerous (i.e. approach 3). However, approach 2
above may be.
6.4.3
Comparison of the approaches with the prevailing legislative framework
The current legislation allows participations in financial institutions to be included in the
capital resources at net asset value less the institution‘s capital requirements.
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Most F&CI participations are likely to have some excess capital. The extent to which its
capital resources exceed its capital requirements will influence whether approaches 1 and 3
above would result in a more conservative assessment of risks than the current regime.
For other financial institutions CEIOPS/EIOPA, APRA, and OSFI are more conservative,
since the current legislation would include the participation at its net asset value.
6.4.4
Conclusions on preferred approach
6.4.4.1 View 1
In order to ensure a level regulatory playing field for financial groups with different corporate
structures, an approach consistent with Basel III is preferred. This should also:
–
–
–
mitigate the risk of contagion within a group (specifically between the insurance and banking
sectors), which is an objective of the CEIOPS/EIOPA recommendations;
avoid the double-gearing of F&CI participations‘ capital where those participations are significant
contributors to the participating (re)insurer‘s own funds; and
be sufficiently onerous as to allow third-country equivalence with Solvency II.
The suggested adjustments to mitigate the disadvantages of the Basel III approach, in
particular the application of a delta-BOF approach, should ensure an appropriate treatment.
6.4.4.2 View 2
The treatment of F&CI participations should correspond exactly to the treatment under
Solvency II and hence EIOPA-DOC-12/467.
6.5 Treatment of (re)insurance participations in own funds and the SCR – South
Africa
6.5.1
Introduction
There are a number of possible approaches to (re)insurance participations regulated under
SAM to consider. In general there are the following key considerations:
1. consistency between the valuation of the participation and the way in which risk is assessed;
2. the nature of the risks faced by the participation and hence the structure of the risk assessment
for the participating (re)insurer (i.e. where in the standard formula are the risks included); and
3. the appropriate stress to apply to the value of the participation in assessing the risk.
The working group could not reach consensus on the appropriate treatment of (re)insurance
participations. The following two subsections discuss the two views held.
6.5.2
View 1
CEIOPS/EIOPA, in CEIOPS-DOC-63/10 (see section 5.2.1), considered the following to be
relevant in assessing the treatment of participations:
1. the double-gearing of capital;
2. ensuring that the capital in each solo entity corresponds to the risk run in that entity;
3. the limiting of systemic risk;
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4. avoiding the contagion of risks within a group through subsidiaries/participations; and
5. avoiding incentives to regulatory arbitrage through group structuring.
A sixth factor relates to the extent to which the weights of some of the above are reduced as
they are captured at the group level. The applicability of these in a South African context
needs to be considered as the relative weightings applied will influence the assessment of
which treatments are deemed appropriate.
View 1 considers all of the principles above to be important. While the group SCR may
mitigate issues in the solo SCR, this would only be at a regulatory level. Furthermore, if the
solo SCR is to be useful then it must appropriately assess the risks run in an entity.
The valuation of participations in the solo entity calculation is fair value (see section 6.3).
The assessment of the risks in (re)insurance participations should therefore be based on the
risks to all elements of fair value.
6.5.2.1 View 1 – considerations
A variety of discussion points are presented below. There is no ―right answer‖ to the way in
which participations are treated for solo entities. This is because there are conflicting
objectives to be met and no methodology will assess the level of risk perfectly. A
simplification is therefore required. A variety of methodologies together with their strengths
and weaknesses are explored below before a reasonable approach is settled on. First,
however, a number of considerations are discussed.
1. The SAM-assessed value (or own funds) does not typically correspond to the fair value of a
(re)insurer.
a. The fair-value can conceptually be split into two components:
i. The own funds considers only the assets and liabilities already on the book of the
(re)insurer, with certain exclusions.
ii. There is a write-up to fair-value (WTFV) component. This primarily represents the
views of the market regarding expected future profitability arising from new
business, but will also include adjustments for items excluded from own funds
and subordinated liabilities.
b. Historically, listed life insurance companies have typically traded at market capitalisations
close to embedded value (EV) (an approximation of own funds). Some companies trade
at a discount to EV; some trade at a premium to EV. The WTFV component of life
insurance companies is therefore typically small compared to own funds, and possibly
even negative.
c. However, listed non-life insurance companies have typically traded at significant
premiums to net asset value (an approximation of own funds). The WTFV component of
non-life insurance companies is therefore potentially large compared to own funds.
d. The above relate to market value. Not all participations are listed, however, and hence
their fair values will need to be determined using a mark-to-model approach. Similar
considerations apply in this case: the mark-to-model fair value can also be conceptually
split into an own funds component and a WTFV component. There is likely to be
considerable uncertainty regarding the appropriate value of the WTFV, however.
2. The level of diversification recognised between the participating (re)insurer and its (re)insurance
participation.
a. In order to meet EIOPA principle 2 above (solo entity SCR reflecting risk), a look-through
should be applied to the risks underlying the assets held. In general this is not possible,
and where it is a detailed look-through is often not practical.
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b. Non-financial participations are likely to have significantly different sets of risks from the
participating (re)insurer, e.g. commodity price risk or company-specific operational risk.
This is unlikely to be the case for (re)insurance participations, however. Thus the level of
diversification of risks with non-financial participations is likely to be higher than that with
(re)insurance participations.
c. Some approximation is therefore required to reflect this lower diversification.
d. The way in which the risk associated with a participation is included (i.e. the structure of
the participation‘s risk assessment) within the standard formula implies a particular level
of diversification between the risks of the participating (re)insurer and its participation.
e. One possible treatment of participations is as equity investments (and hence in the equity
risk module, as per SA QIS1).
i. This implicitly assumes that the level of diversification of risks between the
participating (re)insurer and its participation is the same as that between the
participating (re)insurer and a standard equity.
ii. While this may be appropriate for non-financial participations (e.g. in a mining
company), the extent of diversification between (re)insurers may be significantly
lower. There is the possibility that the diversification of risks is overstated.
iii. For example, consider an insurance company exposed primarily to lapse risk that
owns a participation which is also exposed primarily to lapse risk. The
diversification of risk provided by the investment in the participation is
substantially lower than that where the participation is exposed to, say,
commodity price risk.
f. Another possible treatment is to include a separate participations module alongside the
BSCR (as per SA QIS2).
i. This implicitly assumes that no diversification exists, i.e. that the risk profiles of
the companies are identical.
ii. The diversification between (re)insurers may be understated with this treatment
where they have very different risk exposures (e.g. life vs non-life or life vs
market).
3. The risk profile of the WTFV component of fair value is unknown.
a. SA QIS2 provided a lot of data on the risk profile of (re)insurers‘ own funds.
b. However, the risk profile of the WTFV component is unknown.
c. The following possibilities were discussed:
i. WTFV remains unchanged under a 1-in-200-year risk event, i.e. a 0% stress is
appropriate.
ii. WTFV drops to zero under a 1-in-200-year risk event, i.e. a 100% stress is
appropriate.
iii. The risk profile of WTFV corresponds to that of the own funds. Thus a 1-in-200year risk event would cause WTFV to fall in the same proportion as own funds.
iv. The risk profile of WTFV corresponds to that of equity risk. Thus a 1-in-200-year
risk event would cause WTFV to fall by the appropriate equity risk stress.
v. The risk profile of WTFV is partly determined by company-specific factors (i.e. it
corresponds to that of the own funds) and partly pure equity risk.
d. Some of the considerations relating to these are:
i. WTFV primarily relates to expected profits arising from future new business.
1. An insurer‘s ability to write future new business may be impaired after a
1-in-200-year event affecting its existing business (lower capital to back
new business, possible reputational issues, inability to meet new
business strain).
2. However, for non-life insurers, if the 1-in-200-year event has affected the
industry as a whole, then there may be a hardening of insurance
premiums (and hence higher profit margins) on new business.
In short, WTFV is affected by company-specific factors, but may be more resilient
than own funds.
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ii. Similarly, the market‘s perception of WTFV is highly influenced by its confidence
more generally. This in turn will be strongly influenced by equity prices, and
hence WTFV should be sensitive to changes in the level of the equity market.
e. The risk profile of WTFV is more relevant to non-life insurers since it forms a greater
component of their fair value. (See section 6.5.2.1 points 1.b and 1.c above.)
4. A workbook was developed to assess the possible impact of a variety of treatments of South
African (re)insurance participations. This was based on the results and methodology from the
SA QIS2 exercise. The results relating to the assessment of the appropriate level of diversification
are discussed below. A detailed discussion of the investigation is provided in appendix 8.4.
a. Three treatments were considered:
i. Accounting consolidation, reflecting the true risk position;
ii. SA QIS1, where participations are included in the equity risk module; and
iii. SA QIS2, where participations are included in a separate participations risk
module but attract an equity risk capital charge.
b. Where a (re)insurer holds a participation writing similar risks, the SA QIS1 methodology
understates the risk relative to the accounting consolidation method, while the SA QIS2
methodology is fairly accurate. This is because the SA QIS1 treatment overstates the
diversification benefits that are assumed to exist.
c. Where a (re)insurer holds a participation writing different risks, both the SA QIS1 and
SA QIS2 methodologies overstate the risk relative to the accounting consolidation
method, although SA QIS1 less so. This is because the diversification benefits of
introducing, for example, non-life risks to an insurer exposed mainly to life and market
risks are greater than those obtained by only increasing the market risk (SA QIS1) or by
assuming no diversification benefit (SA QIS2).
d. Where the participation is a split between a life and non-life insurer, the SA QIS1
methodology understates the risk while the SA QIS2 methodology overstates it, for similar
reasons as those above.
e. In the South African market, (re)insurance participations writing life business tend to be
owned by companies writing life business, and similarly for non-life. This suggests that it
may be appropriate primarily to consider the likely diversification between life companies
or non-life companies when determining the simplification used to assess the risk in
(re)insurance participations.
5. Point 4 above discusses the appropriate simplifications in allowing for diversification. It is also
necessary to estimate the most appropriate stress to apply to the fair value of the (re)insurance
participations. The results relating to the investigation into the effect of the (re)insurance
participation‘s solvency level on the appropriate stress to fair value are discussed below. A
detailed discussion of the investigation is provided in appendix 8.4.
a. The appropriate stress to apply to the fair value (based on the assumptions above) varies
significantly depending on the SCR coverage of the participation.
b. The extent of this variation is greater the larger the proportion own funds makes up of the
fair value of the participation.
6. The scope for regulatory arbitrage (EIOPA principle 5)
a. Different standard formula structures and stress percentages affect the extent to which
(re)insurers can alter their risks as assessed through the standard formula through
changes that don‘t alter the actual risks faced, e.g. changes to legal structures.
b. Applying the standard equity risk stress to a participation implicitly assumes certain
characteristics of its risk profile, in particular the extent to which its fair value exceeds the
sum of its SCR and the risk on its WTFV. Participating (re)insurers could therefore reduce
their capital requirements by having their participations hold own funds near to SCR. This
would increase the appropriate 1-in-200-year stress to own funds to close to 100%, and
may result in an implied fair value stress in excess of the SA QIS2 equity stress (47% or
53% post symmetric adjustment, depending on whether the participation is listed).
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c.
The following example illustrates the scope for regulatory arbitrage:
i. Consider (re)insurance participation A with own funds of 200 and an SCR of 100.
Ignore the effect of the WTFV. The risk assessed on this company for its owner is
47% of 200, or 94. (This is based on the SA QIS2 SA equity stress.)
ii. Suppose the owner of A pays up 90 in cash to itself. Thus A‘s own funds
decrease by 90 to 110 while its SCR remains at 100. The risk assessed on this
company for its owner has dropped to 47% of 110, or 51.7. Since there is no
additional risk at the level of the owner (the additional funds are invested in cash),
the owner‘s total risk assessed has decreased by 42.3.
iii. Although the regulatory capital requirement of the owner has decreased, there
has been no change in its actual consolidated risk profile. This is regulatory
arbitrage.
iv. While including the WTFV in the above calculations would change the exact
figures, the relationship between them (and hence the implications) would remain
unchanged.
7. Appropriateness of the solo entity SCR (EIOPA principle 2)
a. Different structures and stress percentages affect the extent to which the solo entity SCR
calculation captures the risks of the (re)insurer. This in turn affects whether or not the solo
entity SCR provides a reasonable assessment of the risks of the (re)insurer.
b. For example:
i. Applying an equity risk stress to (re)insurance participations means that the
known risks within those participations are not covered. The solo entity SCR
would therefore not correctly assess (either over- or understating) the risks to the
participating (re)insurer of its participations.
ii. Including participations in the equity risk module (as opposed to a separate
participations risk module) may result in an inappropriate level of diversification
being assumed between the risks of the participating (re)insurer and its
(re)insurance participations. The level of diversification could be over- or
understated.
6.5.2.2 View 1 – possible risk treatments – diversification
Given the above, three possible approaches relating to the level of diversification between
the (re)insurer and its (re)insurance participation are considered:
1. Include the investment in the participation in the equity risk module, implicitly assuming that the
appropriate level of diversification is in line with equities.
2. Include the investment in the participation in a separate participations module that is added to the
BSCR, implicitly assuming no diversification between the participating entity and its participation.
3. Exclude the participation from the SCR calculation and deduct a risk charge directly from own
funds, as considered by CEIOPS/EIOPA (see section 5.2.2).
The pros and cons of the first approach are as follows:
–
–
It corresponds to the Solvency II treatment of (re)insurance participations.
This potentially overstates the diversification benefit between the risks faced by the participating
(re)insurer and the participation. This conflicts with EIOPA principle 2. Practically, this is more
likely to be an issue where the two entities have similar risk exposures. In a South African context,
(re)insurance participations appear typically to write the same class (life vs non-life) of business
as the parent. Hence this is likely to be an issue.
The pros and cons of the second and third approaches are as follows:
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–
–
This potentially understates the diversification benefit between the risks faced by the participating
(re)insurer and the participation. This conflicts with EIOPA principle 2. Practically, this is more
likely to be an issue where the two entities have different risk exposures. In a South African
context, (re)insurance participations appear typically to write the same class (life vs non-life) of
business as the parent. Hence this is less likely to be an issue.
This is unlikely to understate the appropriate capital requirement.
The second approach has the advantage over the third approach that it results in an SCR
and capital coverage ratio for the participating (re)insurer that better reflect the inherent risk.
An example illustrating this is provided in appendix 8.3.
Given the above, view 1 is that (re)insurance participations should be considered in a
separate risk module from standard equity exposures. This avoids potentially overstating
diversification benefits and hence understating the SCR. In a South African context, this
means that the solo entity SCR is more likely to correspond to the underlying risk (EIOPA
principle 2).
This treatment corresponds to the recommendation specified in CEIOPS-DOC-63/10
¶A.1 a).
A possible refinement to this approach (Approach 2) is to have separate sub-modules
contributing to the single participations module. For example, sub-modules A and B are
aggregated to determine the participations risk module, which is then added to the
participating (re)insurance company‘s BSCR. This would allow diversification benefits
between (re)insurance participations to be recognised if appropriate. For example:
–
–
–
All life participations could be stressed under sub-module A and non-life participations under B.
A and B could then be aggregated assuming a correlation below 1 to reflect the diversification
between the life risk in A and the non-life risk in B. This aggregation would give the participations
risk module.
The participations risk module could then be added to the participating (re)insurer‘s BSCR.
This is recognised as a possible refinement and will be tested in QIS3. However, allowing for
diversification between participations will make the double-gearing of capital possible: the
assets backing the capital requirement of the participation may not be required to back its
reduced contribution to the capital requirement of the participating (re)insurer.
6.5.2.3 View 1 – possible risk treatments – stress percentage
Two possible simplifications relating to the appropriate stress for the participation are
considered:
1. Apply a standard equity stress to the fair value of the participation.
2. Apply a stress modified for the riskiness of the participation to its fair value.
Before considering the relative merits of these, the possible ways of modifying the stress
percentage must be explored. This is done with reference to the conceptual split of fair value
between the own funds and WTFV. An appropriate, SAM-consistent risk treatment of the
own funds of a (re)insurer is given through its SCR. That is, the appropriate stress to the
own funds is the SCR. An appropriate treatment of the WTFV must therefore be determined.
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Point 3 in section 6.5.2.1 considers the following possibilities, which are briefly analysed
below:
1. Apply a stress of 0%.
a. This is likely to understate the riskiness of WTFV and hence fair value.
2. Apply a stress of 100%.
a. This is likely to overstate the riskiness of WTFV and hence fair value.
b. It would be consistent with the APRA methodology, which deducts goodwill and other
intangibles on regulated subsidiaries from available capital. (GPS112 ¶12–13.)
3. Apply a stress of SCR / own funds.
a. The stress to WTFV will reflect company-specific factors.
b. This will result in a stress to fair value of SCR / own funds.
4. Apply an equity stress (e.g. 47%).
a. The stress to WTFV will reflect general equity market factors.
5. Apply a stress that is a function of SCR / own funds and the equity stress.
a. This will allow the stress to reflect both company-specific factors as well as general equity
market factors, which is intuitive.
Given the above and the practicalities of the standard formula, a simple function of
SCR / own funds could be specified:
–
–
In order to avoid assumptions relating to the proportion of fair value made up by WTFV, as well as
specifying separate stresses for life and non-life insurers, a formula with the fair value and own
funds as inputs could be used.
A stress to WTFV that is a function of SCR / own funds and the equity stress would provide the
most appropriate estimate of the risk of the WTFV (and hence is the methodology most aligned to
EIOPA principle 2). However, the resultant specification of the stress would require assumptions
relating to the relative sensitivity of the WTFV to company-specific and general equity factors. For
simplicity it could therefore be assumed that the relevant equity stress is applicable to the WTFV.
The following inputs would therefore be required for each participation i:
Ai
The SAM fair value of (re)insurance participation i, which is the value at which
it is included in the assets;
Fi
The SAM own funds of (re)insurance participation i attributable to the
participating (re)insurer;
Ci
The SAM SCR of (re)insurance participation i attributable to the participating
(re)insurer.
ei
The SAM SA equity, global equity, or other equity stress percentage, as
appropriate to participation i.
The stress applicable to the fair value of (re)insurance participation i (si) is such that the own
funds are stressed by the SCR while the WTFV is stressed by the equity stress percentage.
The stress is therefore determined through the following formula:
si 
Fi Ci  Fi 
 1  ei .
Ai Fi  Ai 
The participating (re)insurer should disclose all relevant information relating to its
(re)insurance participations. That is, for each (re)insurance participation i, Ai, Fi, Ci, ei, and si
should be disclosed.
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The stress percentage applicable to the fair value is a function of the (re)insurance
participation‘s own funds and SCR. This information is therefore required before the stress
can be performed. However, this data requirement is in line with the current regulatory
regime. Board Notice 14 of 2010 section 8.1 stipulates that a ―group undertaking‖ that is a
―regulated financial institution‖ should be valued at the value of its assets less the sum of its
liabilities and regulatory capital requirement.
It is suggested that, where the SCR coverage at the valuation date is not available, the
participating (re)insurer should use a prior coverage ratio or a reasonable approximation of
the current coverage ratio.
Returning to the comparison of the relative pros and cons of the two treatments, those of the
first treatment are as follows:
–
–
–
–
–
–
It is a simpler approach.
It corresponds to the Solvency II treatment of (re)insurance participations.
Applying the equity risk stress does not capture the known riskiness in the participation, e.g. if its
own funds are only marginally above its SCR. The solo entity SCR would therefore not correctly
assess (either over- or understating) the risks to the participating (re)insurer of its participations.
This would mean the solo entity SCR would not correspond to risks run (EIOPA principle 2).
This would also leave scope for regulatory arbitrage at the solo entity level, as demonstrated in
point 6.c of section 6.5.2.1. This would not meet EIOPA principle 5.
It avoids specifying an appropriate treatment of the WTFV.
Assuming a standard equity stress ignores the illiquidity of the significant holdings in the
participation (the sale of over 20% of the share capital of a company is likely to affect the value of
the investment significantly). This will particularly be the case during a 1-in-200-year event.
The pros and cons of the second treatment are as follows:
–
–
–
–
–
The approach is more complex and requires additional data. (However, the current CAR regime
already effectively requires this on the current statutory basis.)
It deviates from Solvency II.
It more accurately reflects the known risks of the equities of the (re)insurance participation. This
helps to maintain the appropriateness of the solo entity calculation, meeting EIOPA principle 2.
It is less open to regulatory arbitrage since it reflects (and is sensitive to) the known risks of the
(re)insurance participation, helping to meet EIOPA principle 5.
It reduces the possibility of the double-gearing of capital since the (re)insurance participation‘s
own funds are stressed by the SCR. This helps to meet EIOPA principle 1.
Given the above, view 1 is that stress percentage applied to equity investments in
(re)insurance participations should vary depending on that participation‘s solvency.
This methodology corresponds CEIOPS‘ majority-view proposal and APRA‘s treatment of
(re)insurance participations in that the contribution of a participation‘s own funds to the
solvency of its parent is impaired by the regulatory capital requirement. The nature of this
impairment differs, however, since the view 1 methodology adds to the parent‘s regulatory
capital requirement rather than subtracting from its capital resources. The treatment of the
WTFV differs too: CEIOPS and APRA value this at nil, while the view 1 methodology applies
a less onerous equity stress.
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It is also instructive to compare the proposed methodology with that specified in CEIOPSDOC-63/10 ¶A.2 (which is an SCR-based approach consistent with the majority-view own
funds approach). The CEIOPS approach takes the SCR attributable to the participating
(re)insurer as the stress. Furthermore, ―any inherent goodwill in the valuation of the
participation‖ is treated under the intangible assets risk module. (This corresponds to the
WTFV component of the fair value.) Thus:
–
–
The treatment of the own funds component of fair value is the same, since the stress applied is
the attributable SCR.
The treatment of the WTFV differs. CEIOPS‘ majority-view approach considers this under the
intangible assets module; the view 1 approach applies the appropriate equity risk charge (in the
participations risk module).
6.5.2.4 View 1 – Impact of the approaches on EU 3rd country equivalence
EIOPA-DOC-12/467 provides the likely final Solvency II treatment for (re)insurance
participations. It includes (re)insurance participations in the equity risk module and applies
the equity risk stress. The alternatives considered under view 1 (a participations risk module
added to the BSCR and a modified stress percentage) are more risk-sensitive than this.
They are therefore not expected to affect third country equivalence.
6.5.2.5 View 1 – Comparison of the approaches with the prevailing legislative framework
For participations in (re)insurers, the current CAR regime applies the deduction and
aggregation approach considered in the group calculation. Since (re)insurance participations
are valued at market value (or fair value) in the solo entity calculation, this methodology is
not easily applied in the solo calculation. However, reducing the diversification benefit and
modifying the stress attempt to introduce some level of correspondence between the two.
This is because the actual riskiness is allowed for (through modifying the stress percentage),
and diversification between the same classes of risk is not allowed (through including the
participation at the BSCR level).
6.5.2.6 View 1 – Conclusions on preferred approach
The preferred approach under view 1 is to consider equity holdings in (re)insurance
participations in a separate participations risk module that is added to the BSCR. This
reduces the likelihood of overstating the diversification benefit between entities exposed to
similar risks relative to considering them in the equity risk module. This is in line with the
South African insurance market, where (re)insurance participations and their parents
typically write similar business (as per SA QIS2). This treatment helps to meet EIOPA
principle 2.
Furthermore, the preferred approach under view 1 is to apply a modified stress percentage
to equity holdings in (re)insurance participations. The modified stress percentage reflects the
solvency level of the participation. The stress applied therefore better reflects the risks
inherent in the participation, and so is less open to regulatory arbitrage and reduces the risk
of the double-gearing of capital. This treatment helps to meet EIOPA principles 1, 2 and 5.
The preferred approach is consistent with CEIOPS-DOC-63/10 annex A, with the exception
of the treatment of the WTFV. The preferred approach applies an equity risk charge in the
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participations risk module to the WTFV; the CEIOPS approach considers the WTFV in the
intangible asset risk module.
In the South African context additional consideration needs to be given to micro-insurers.
The micro-insurer legislation has not been finalised. It is however recommended that they be
treated the same as (re)insurers.
6.5.3
View 2
The second view basically follows the principles applied by Solvency II, with some potential
simplifications for South African insurance industry, for example that all participations are
identified and treated as strategic participations. Details of the preferred approach under
View 2 are provided in Appendix 8.2.
The following is a high-level summary for purposes of the discussion and comparison with
View 1:
View 2 follows the same treatment of participations in own funds as View 1, but proposes a
different treatment for (re)insurance participations in the SCR. As per Solvency II it is
proposed that equity holdings in participations are stressed in the equity risk module as any
other equity investment.
View 2 is premised on solo capital requirements being driven solely by the fair value
fluctuations of participations (the basis on which these are valued in the solo balance sheet).
The assessment of the risks in (re)insurance participations should therefore be based on fair
value and how this value will change in a 1 in 200 year event.
View 2 argues that the group SCR and Own Funds calculations will incorporate exactly the
correct amount of own funds and risk for each participation via the consolidation of
participations. Any concentration of risks undertaken by the participation with the
participating insurer is reflected by the Group SCR calculation.
The solo treatment should not be prejudiced against the direct ownership of participations by
introducing prudence not reflected in the Group requirements.
6.5.3.1 View 2 – considerations
Various considerations were listed under View 1 and these are discussed below under the
same headings from a View 2 perspective. The various discussion points are not listed
again, only the conclusion for View 2.
1. The SAM-assessed value (or own funds) does not correspond to the fair value of a
(re)insurer.
For the purposes of solo capital resources and capital requirements, the SAM
assessed value is not relevant. Insurance participations only contribute to the
volatility of the BOF of an insurer via fluctuations in their fair value as it should reflect
the support policyholder interests in the solo entity can gain from these investments.
The SAM assessed value is only relevant to the group calculation as it assumes a
shared pool of capital resource which could be relied upon to support shared risks
across the group.
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2. The level of diversification recognised between the participating (re)insurer and its
participation.
If the participation is stressed in the equity risk module the diversification is assumed
to be the same as the diversification between the equity risk module and other risk
modules. From a solo perspective any insurer holding equity of participation is only
exposed to losses caused directly by a fall in the value of the equity held. There are
no direct causal link between any other risks and potential losses w.r.t. the equity
holding.
For the standard formula, no allowance is made regarding sectoral concentration of
investments. Some allowance is made in the counterparty investment concentration
sub-module, but its intention is focussed on aggregating equity and debt exposures,
rather than to address sectoral concentration issues.
Similarly, there are many examples where more extreme market price re-valuations
have occurred (affecting the value of the participation on the balance sheet of the
solo entity) at times when the solo did not experience the same stressed conditions
that are applicable to entity in which the participation is being held. The question
reduces to whether other risks contributing towards the SCR are as independent of
the fair value of insurance participations as they are of general equity holdings. Given
the high level nature of the assumptions used to derive the correlation matrix, there is
very little evidence that can be produced to justify the assertion that it is indeed
different.
The market price movements of insurers do suggest that some diversification is
justified as historic betas of the insurance sector have been lower than 1,
Reduced diversification benefits also introduce discontinuities in so far as the
effective capital charge is concerned, e.g. consider the marginal impact of an
additional 1% investment in an insurance participation for an insurer which has a
19% interest in an insurance entity.
At the other extreme, there will be significant differences in diversification benefits
enjoyed at a solo level between a wholly owned subsidiary or consolidating the
subsidiary‘s business on the owner‘s license. (Note there would not be a difference
on the group.
3. The risk profile of the WTFV component of fair value is unknown.


View 2 agrees that the WTFV component is unknown.
This is however, not a problem for View 2 as the full fair value is stressed.
4. The scope for regulatory arbitrage (EIOPA principle 5)
Where a (re)insurer have a (re)insurance participation the parent will have to do a
group solvency assessment as well as a solo solvency assessment. Both of these
will have to be reported to the regulator. Therefore there can be no regulatory
arbitrage as the regulator will have the group view which shows the accurate
solvency situation of the group.
The discontinuities mentioned in point 2 above result in larger potential for arbitrage
opportunities when reporting solo capital cover assessments. As an example,
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consider the case where some of the participation‘s business is reinsured with the
solo owner.
5. Availability of information
Another complication will be the availability of information at the point of assessing
solo level solvency. Given the shortened timelines under SAM an insurer will not
have solvency information for their participations, i.e. own funds and SCR, available
in time for the completion of solo level regulatory returns. Therefore insurers will not
be able to determine the risk of the participation in order for a stress to be based on
the participation‘s solvency as this information will not be available.
The preferred approach under View 2 will thus not require the participating insurer to
approximate any calculations performed by the participation and therefore avoids
potential moral hazard introduced by such approximations.
6.5.3.2 View 2 – Advantages and disadvantages
Advantages of View 2
1. As View 2 is aligned with EIOPA‘s technical specifications it will thus:
a. Comply, by definition, with the principles and objectives set by
EIOPA/CEIOPS e.g. principles listed in paragraph 6.6.2 of View 1;
b. Not impact 3rd country equivalence.
c. Ensure SAM takes advantage of the latest development of the
Solvency II specifications (including the fact that Solvency II elected to
not adopt the approach preferred in CEIOPS-DOC-63/10);
d. local insurers will have fewer significant deviations from Solvency II to
explain to external stakeholders such as rating agencies, international
investors/analysts, international clients and business partners;
e. local insurers are treated on an equal footing with those regulated by
Solvency II in so far as the treatment of insurance participations on
their solo balance sheets are concerned
2. View 2 provides (re)insurers with the necessary detailed requirements in order to
analyse the data, models and other system changes required to comply with
SAM and to progress their individual SAM implementation projects across all
three pillars with regard to the solo treatment of participations.
3. The approach proposed under View 2 does not require (re)insurers to treat
different types of equity participations for solo purposes in a different manner. I.e.
the same approach is followed for (re)insurance, financial and credit institutions,
non-regulated financial and non-financial participations; for related entities inside
South Africa as well as non-SA participations.
4. View 2 recognises that the treatment of participations from a solo perspective
differs from the group view with different role players (e.g. management, board,
appointed actuary, etc.) at the solo level that are accountable to the relevant
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stakeholders of the relevant solo entity (e.g. policyholders, shareholders,
employees, regulator, etc.).
As such, under View 2 the solo solvency
assessment is seen as complementary to the group solvency (i.e. solo not aimed
to be a proxy of the ―consolidated‖ group view).
5. Arguments in support of View 2 are not based on newly defined, untested
concepts (e.g. ―WTFV‖).
6. All information is available to do the calculation at the relevant point in time and
does not rely on historic SCR and own fund information.
7. Since View 2 is driven by the fair value fluctuation of the participation (all of the
fair value and the fair value only) it provides a better assessment of the risks to
the solo entity‘s balance sheet (the latter only being impacted by fair value
volatility rather than by SCR coverage).
8. View 2 provides for more linear increases in capital charges associated with
increased holdings. This approach is significantly easier to explain to
stakeholders engaged in risk-based decision surrounding increasing/decreasing
stakes in insurance participations.
9. View 1 would incentivise a group structure where insurance participations are not
held by solo entities but rather by insurance groups. This would reduce the level
of security policyholders would benefit from as recourse to assets in a stressed
event would be via the group structure. If insurers were to re-structure so as to
improve the solo capital cover reported under view 1:
a. it would not change the group position
b. policyholder benefits would not be more secure (as reported) but in
fact less secure (as explained above).
Disadvantages of View 2
1. It is not sensitive to information available on the risks of the participation in so far
as its own assessment under SAM is concerned.
However, the disadvantage above is exactly why a group view is required and
therefore will be addressed there.
6.5.3.3 View 2 – Impact of the approaches on EU 3rd country equivalence
EIOPA-DOC-12/467 provides the likely final Solvency II treatment for (re)insurance
participations. It includes (re)insurance participations in the equity risk module and
applies the equity risk stress. Therefore View 2 is aligned with EIOPA‘s view and will
not have any impact on 3rd country equivalence.
6.5.3.4 View 2 – Comparison of the approaches with the prevailing legislative framework
Current CAR calculations do not require the stressing of participations on a solo level
and therefore View 2 will be more conservative.
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6.5.3.5 The relative treatment of participations between view 1 and view 2:
Aside from considering the relative advantages and disadvantages (which would
include practical considerations) of the two views, the conclusion would need to
address two specific questions:
1. What drives the fair value fluctuation of (re)insurance participations (as this is the
mechanism which introduces risk to the participating insurer‘s balance sheet)?
2. Depending largely on the answer to question 1 – how should this be diversified in
the participating insurer‘s SCR?
Question 1:
The standard formula‘s equity risk sub-module does not currently allow for any additional
charge relating to concentration of investments in specific sectors. Some assessment is
required as to what extent the fair value of insurers fluctuate in line with general equity
movements. This is a question that could be quantified using market information and
approximations for SCR coverage. Some inferences could also be drawn from the significant
component of (re)insurers‘ SCR associated with market risk and equity risk in particular.
View 1 is consistent with an explanation that the fair value volatility of (re)insurance
participations can be best explained by splitting it into the own funds covering the SCR and
the write-up to fair value components.
View 2 is consistent with the assumption that not only does the calibration of the equity risk
sub-module reflect this volatility adequately, but that there is a strong correlation between
these, especially in extreme events.
The graphic below illustrates the different treatment of two insurance participations (or the
same insurer at different points in time) on the participating insurer‘s solo balance sheet,
both of which have the same fair value under the two different views. (An equity stress of
43% was assumed to apply in the equity risk sub-module.)
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Scenario 1
View 1
Write up
to fair
value
= 100
Fair value
= 200
Own
funds
= 100
add to
SCR = 43
SCR = 100
View 2
add to
SCR = 43
SCR = 100
57
SCR = 43
Scenario 2
Write up
to fair
value
= 100
Fair value
= 200
Own
funds
= 100
add to
SCR = 43
OF
overage of
SCR = 80
OF
overage of
SCR = 80
SCR = 20
SCR = 20
add to
SCR = 43
57
SCR = 43
View 1 would add 143 of undiversified capital charges to the BSCR in scenario 1 and 53
under scenario 2.
View 2 would add 86 of capital charges to the equity risk sub-module which would reduce
with diversification in both scenarios.
Question 2:
If the answer to question 1 is consistent with view 1, then question 2 would address how
these components would best be aggregated with the other SCR items. The current
proposal; under view 1 would treat these components similarly and not allow any
diversification with other SCR components. This may be true in of the Own funds covering
the SCR component in the extreme example where exactly the same profile of risks is taken
on by the participation and the participating insurer. Additional evidence would need to be
provided to substantiate that the fair value component is exactly correlated with the level of
own fund coverage prior to making an assumption that is as conservative as not allowing
any diversification of this component with other risks considered in the SCR.
The exact nature of the aggregation/diversification calculation would thus still depend on the
answer to question 2. Currently view assumes the most conservative answer to question 2.
If the answer to question 1 is consistent with view 2, then question 2 would imply that this fair
value fluctuation could be aggregated to the SCR as for any other equity risk.
6.5.4
Summary of alternative approaches
The methodologies discussed above can be summarised by considering the following:
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1. the stress applied to the participation, and
2. the allowance for diversification between the risks inherent in the participation and those of the
participating (re)insurer.
Diversification
As for other equity None recognised
investments
Stress applied
to participation
Standard equity
SCR-based
View 2
SA QIS 3 – Default
View 1
Table 6.5.4-1: Categorisation of the alternative methodology approaches
The table above shows that, while only two views have been suggested in the sub-sections
above, there are four permutations in the approach that arise. Elements of these have also
been discussed in those sub-sections, e.g. sub-sections 6.5.2.2 and 6.5.2.3. Secondly, while
view 1 and view 2 had been the preferred approaches considered in more detail by the
Participations working group, the SA QIS 3 ―default approach‖ is neither of these two
approaches (the top right permutation in the table above), although view 1 and view 2 are
considered as ―alternative approaches‖.
6.6 Treatment of (re)insurance participations in own funds and the SCR – not South
African
6.6.1
Discussion of inherent advantages and disadvantages of each approach
The appropriate treatment of (re)insurance participations not regulated under SAM (i.e. nonSouth African participations) may differ from those that are regulated under SAM for the
following reasons:
–
–
Any non-South African participations will provide greater geographical (and hence likely risk)
diversification than South African participations. This is the case even if the risk profile is the
same.
The data required to modify the stress percentage, as considered in section 6.5 above, may not
already be being calculated for the regulator of the participation.
CEIOPS/EIOPA, in CEIOPS-DOC-63/10 (see section 5.2.1), considered the following to be
relevant in assessing the treatment of participations:
1.
2.
3.
4.
5.
the double-gearing of capital;
whether each solo entity SCR assessment corresponds to the risk run in that entity;
the limiting of systemic risk;
avoiding a contagion of risk within a group through subsidiaries/participations; and
avoiding incentives to regulatory arbitrage through group structuring.
A sixth factor relates to the extent to which the weights of some of the above are reduced as
they are captured at the group level. The applicability of these in a South African context
needs to be considered as the relative weightings applied will influence the assessment of
which treatments are deemed appropriate. In the context of non-South African (re)insurance
participations, factors 3 and 4 are less applicable due to geographic diversification.
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The valuation of participations in the solo entity calculation is fair value (see section 6.3).
The assessment of the risks in (re)insurance participations should therefore be based on fair
value.
The recommendation for the treatment of (re)insurance participations in non-equivalent
jurisdictions for the group entity calculation is set out in SAM Position Paper 85. The issues
considered therein (§5 of version 8.0) are:
1.
2.
3.
4.
5.
6.
7.
How to determine whether the participation is a part of the group;
Principles applied by credit rating agencies to evaluate parental support;
Practical and computational demands;
Comparison with the banking industry;
Usefulness of the local capital adequacy requirements;
South African approach towards economic development in SADC; and
A level playing field vis-à-vis local operations.
Given the above, SAM Position Paper 85 section 6.1 recommends that SAM calculations for
(re)insurance participations in non-SAM equivalent regimes should not be required where:
–
–
–
The operation is not regarded as ―strategically important‖ (as defined in the paper);
The South African parent is prepared to include the participation at nil in its own funds and SCR,
and the participation is solvent based on its local statutory assessment; or
The operation is subject to a local risk-based regulatory regime.
The following other considerations should be noted:
–
–
Requiring participations to develop robust internal economic capital models would be good risk
management. Thus, although regulator-approved economic capital figures may not be available,
internal figures may be.
However, this may be considered overly onerous and therefore discourage (re)insurers from
establishing themselves in jurisdictions with non-SAM equivalent regulatory regimes (which are
likely to be under-developed markets).
The working group felt that, in line with SAM Position Paper 85, (re)insurance participations
in countries other than South Africa should be treated as those in South Africa. (That is,
either view 1 or view 2, as per section 6.5.)
–
View 1-specific considerations:
o Although non-South African (re)insurance participations do provide greater diversification
of risk than South African (re)insurance participations, treating them consistently should
mean that the risk on non-South African (re)insurance participations is unlikely to be
understated.
o SAM Position Paper 85 paragraph 6.2 recommends that ―SA SAM calculations will be
required‖ for non-South African insurance operations in non-equivalent jurisdictions,
unless:
 the operation is not strategically important;
 the parent is prepared to include the company, which is solvent on a local
prudential basis, at nil in its own funds and SCR (and hence no capital
requirement calculation is needed in respect of the participation); or
 the local prudential regulatory regime is risk-based (and hence the local
prudential capital requirement and available capital could be used as proxies for
the SCR and own funds respectively).
In general the data required for the view 1 calculations should therefore be available if
required. Where they are not (i.e. for participations that are not strategically important, are
not included at nil or are insolvent on a local prudential basis, and which do not operate
under a risk-based prudential regime), suitable proxies should be used. If it is appropriate
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to apply the principle of proportionality to the assessment of the risk inherent in the
participation, assuming a zero SCR and own funds and hence applying a standard equity
stress may be appropriate.
6.6.2 Impact of the approaches on EU 3rd country equivalence
Since neither view 1 nor view 2 for South African (re)insurance companies is expected to
jeopardise EU third-country equivalence, the same is expected for non-South African
(re)insurance companies.
6.6.3 Comparison of the approaches with the prevailing legislative framework
The same considerations as under view 1 and view 2 in section 6.5 apply to non-South
African (re)insurance companies.
6.6.4 Conclusions on preferred approach
The same considerations as under view 1 and view 2 in section 6.5 apply to non-South
African (re)insurance companies. It was felt appropriate to apply the same standards to both
given the recommendations in SAM Position Paper 85.
6.7 Treatment of financial, non-regulated participations
6.7.1
Discussion of inherent advantages and disadvantages of each approach
Participations in financial non-regulated entities should be treated with financial and credit
institutions (F&CIs). This is in line with EIOPA-DOC-12/467 ¶SCR.14.8:
–
―Any institution which performs the functions or carries out the business described pursuant to [a
regulated F&CI]… should be treated as a financial and credit institution notwithstanding that it
may not be subject to the Directives [i.e. is not regulated].‖
Furthermore, the CEIOPS/EIOPA recommendation discussed in sections 5.2.1 and 5.2.2
corresponds with this. It is appropriate to treat non-regulated financial participations in line
with F&CI participations (discussed in section 6.4) for the following reasons:
–
–
–
The objective of reducing contagion risk is met, since this is one of the objectives of the treatment
of F&CI participations;
It is consistent with the treatment of financial participations under Basel III; and
There is no regulatory requirement for the participation to calculate its risk profile, and hence an
approach more accurately reflecting its risks may not be feasible.
The disadvantage of this approach is that it may result in a prudent assessment of the
participation. Equally, however, where the appropriate risk capital would exceed the
assessed value, it may result in an aggressive assessment of the participation.
6.7.1
Impact of the approaches on EU 3rd country equivalence
This is discussed in section 6.4.2.
6.7.2
Comparison of the approaches with the prevailing legislative framework
This is discussed in section 6.4.3.
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6.7.3
Conclusions on preferred approach
This is discussed in section 6.4.4.
6.8 Treatment of non-financial participations
6.8.1
Discussion of inherent advantages and disadvantages of each approach
As with non-regulated financial participations (considered in section 6.7), non-financial
participations will not have a regulatory requirement to determine a risk capital requirement.
However, unlike financial participations, the risk of financial contagion arising through the
participation will be limited.
Some issues relevant to non-financial participations are:
–
–
the diversification of risks with the participating company, and
viewing participations as standard equity investments.
Unlike participations in (re)insurance companies, the diversification of risks with non-financial
participations is likely to be similar to the diversification of risks with standard equity
investments. Similarly, there is unlikely to be a risk assessment of the participation that is
more appropriate than a simple equity stress. However, unlike standard equity investments,
the significant holdings in participations are likely to be relatively illiquid: the sale of over 20%
of the share capital of a company is likely to affect the value of the investment significantly.
Theoretically, a non-financial participation that is subject to prudential regulations could have
an analysis applied to it similar to that applied to (re)insurance participations under view 1.
This would result in a non-standard equity stress. There are unlikely to be a significant
number of non-financial prudentially-regulated participations, however. A standard equity
stress was therefore considered sufficient.
Some (re)insurance companies subject to SAM may hold non-financial participations in order
to fulfil certain business needs. The failure of such a participation would have effects beyond
the loss of value of the asset, e.g. the loss of a critical service. This was felt to be better
addressed under the framework of the ORSA, however, rather than the standard formula.
Given the above:
–
–
It may be appropriate to consider non-financial participations in either an equity risk module or
participations risk module, although there is less need to limit the diversification allowed for.
It may be appropriate to apply an equity stress to non-financial participations, although given the
illiquidity of the holding it may be appropriate to apply a more penal stress percentage (e.g. that of
other equity even for global and SA-listed equities).
6.8.2
Impact of the approaches on EU 3rd country equivalence
EIOPA-DOC-12/467 provides the likely final Solvency II treatment for participations. It
includes participations in the equity risk module and applies the equity risk stress. This is the
treatment considered above, and so there will be no effect on third country equivalence.
6.8.3
Comparison of the approaches with the prevailing legislative framework
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The current legislation includes non-financial participations at the greater of net asset value
and fair value, as defined by accounting standards. The proposed SAM approach therefore
differs in that they should always be recognised at market value or, where not available, fair
value.
6.8.4
Conclusions on preferred approach
The recommendation for the assessment of risk in non-financial participations treats them as
ordinary equity investments. This reflects the expected level of diversification between the
participation and the participating (re)insurer.
6.9 Treatment of strategic participations in the own funds and SCR
6.9.1
Introduction
Solvency II defines and treats separately ―strategic participations‖ (see section 5.2.3). The
working group was of the opinion that no difference in treatment of strategic participations
was necessary. As such, no definition of a strategic participation is necessary. (Any
definition specified should relate to the differences in the treatment of strategic
participations.)
As discussed in the preceding sections, SAM position paper 39 specifies the appropriate
value for participations in the solo entity calculation is the fair value (mark-to-market or markto-model). Two possible treatments of the risks were discussed:
1. Treating strategic participations as other participations.
2. Treating strategic participations separately from other participations. This is in line with EIOPADOC-12/467. This treatment may, for example, involve applying a stress of 22% to the fair value.
See section 5.2.3.
The following subsection discusses why the working group is of the opinion that no
difference in treatment is required.
6.9.2
Discussion of inherent advantages and disadvantages of each approach
The 22% stress in EIOPA-DOC-12/467 contrasts with equity risk stresses being applied to
non-strategic participations (39% and 49% pre symmetric adjustment). It is not clear why the
22% is recommended. Some possible reasons are explored below.
–
–
The lower 22% stress is intended to reflect the following:
(1) (Re)Insurers are likely to have a greater degree of control over strategic participations.
(2) It may be argued that the long-term nature of the holding makes it appropriate to smooth
the stress.
(3) The value derived from the strategic participation may not come purely from share price
performance.
However:
(1) Greater control may not result in lower risk, e.g. (re)insurers do not get relief from their
own risks simply because they have control over their own affairs when looking at a solo
assessment of capital.
(2) The market-consistent valuation of the strategic participation is an unsmoothed value.
(The valuation of the strategic participation is at market value or fair value.) Use of a
smooth 22% stress therefore makes the valuation inconsistent with the risk assessment.
(3) Where value is derived from sources other than share price performance, the company is
then also exposed to loss from those other sources. That is, the strategic participation
may not be in a position to add that value during or after a stress event.
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As such, there is no clear justification for treating strategic participations differently from nonstrategic participations.
6.9.3
Impact of the approaches on EU 3rd country equivalence
Not making a distinction between strategic and other participations is not expected to
influence third-country equivalence with Solvency II.
6.9.4
Comparison of the approaches with the prevailing legislative framework
The current regulatory regime does not distinguish between strategic and other
participations.
6.9.5
Conclusions on preferred approach
The preferred approach is not to distinguish between strategic and other participations. It is
unclear why Solvency II is applying a reduced stress to strategic participations. Furthermore,
the reduced stress is inconsistent with the use of the market value for the solo entity
calculation under SAM.
Not distinguishing between strategic and other participations avoids any requirement for a
definition.
6.10
The treatment of concentration risk
6.10.1 Discussion of inherent advantages and disadvantages of each approach
The purpose of the concentration risk module is to reflect the additional risk arising from a
non-diversified portfolio of investments: the 1-in-200-year stress applicable to a single equity
is higher than that applicable to a diversified portfolio. Individual investments will have
specific risk profiles that are not reflected in the standard market risk sub-modules. Thus,
where the specifics of the risks of an asset are reflected in its treatment elsewhere in the
SCR (or own funds), it need not be included in the concentration risk module.
6.10.1.1
SA QIS3
Under SA QIS3 (¶SCR.6.7.1), the concentration risk sub-module was applied to all assets,
excluding:
–
–
strategic participations, and
non-strategic participations in F&CIs that are excluded from own funds.
This appears to differ from the treatment under EIOPA-DOC-12/467, which is discussed in
section 5.2.3. However, ¶SCR.6.7.30 of SA QIS3 aligns the treatment with that specified in
EIOPA-DOC-12/467, as they mirror EIOPA-DOC-12/467 ¶SCR.5.116 and ¶SCR.5.134.
(These paragraphs remove any entities that are a part of the same group from the
concentration risk module.)
6.10.1.2
Considerations relating to concentration risk in participations
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EIOPA-DOC-12/467 ¶SCR.5.109 (and SA QIS3 ¶6.7.4) state that for concentration risk
―exposures which belong to the same group should not be treated as independent
exposures‖. This is generally sensible. However, where these exposures are to
participations this group includes the participating company itself. In this case it is less
sensible to aggregate exposures since that would include the (re)insurer‘s exposure to itself.
For participations the calculation of concentration risk should therefore be based on
exposures at the level of legal entities and not groups.
6.10.1.3
Treatment of assets in preceding sections
In sections 6.1 to 6.9 above all financial instruments issued by participations are included in
the market risk module except the following:
1. investments in F&CI participations excluded from the participating (re)insurer‘s own funds;
2. view 1 of equities issued by (re)insurance participations, which includes them in a separate
participations risk module and applies a stress percentage modified to reflect the SAM-assessed
risks of the participation.
In all of the above, the exclusion from the market risk module is theoretically such that the
specifics of the risks are reflected. It would therefore not be appropriate to include any of
these (investments in F&CI participations, (re)insurance participations under view 1) in the
concentration risk module.
It is not clear why EIOPA-DOC-12/467 excludes participations in general from the
concentration risk module, since these still present a potential source of concentration of
risk.
Two separate views existed within the working group. These are briefly discussed below:
–
–
View 1:
(1) The concentration risk module should reflect all investments where the standard formula
does not capture the specifics of the risk profile of that investment.
(2) Applying this to participations: all participations other than investments in F&CIs excluded
from own funds and (re)insurance participations under view 1 of section 6.5 should be
included in the concentration risk module.
View 2:
(1) The concentration risk module should exactly reflect EIOPA-DOC-12/467.
(2) Applying this to participations: No capital requirement should apply for the purposes of
the concentration risk sub-module to exposures of undertakings to a counterparty which
belongs to the same group, provided that the following conditions are met:
 the counterparty is an insurance or reinsurance undertaking or a financial holding
company, asset management company or ancillary services undertaking subject
to appropriate prudential requirements;
 the counterparty is included in the same consolidation as the undertaking on a full
basis; and
 there is no current or foreseen material practical or legal impediment to the
prompt transfer of own funds or repayment of liabilities from the counterparty to
the undertaking.
6.10.2 Impact of the approaches on EU 3rd country equivalence
The recommended approach under view 1 may result in more instruments being included in
the concentration risk module than as envisaged in EIOPA-DOC-12/467. View 2 exactly
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replicates EIOPA-DOC-12/467. As such, neither is expected to influence third-country
equivalence with Solvency II.
6.10.3 Comparison of the approaches with the prevailing legislative framework
The prevailing legislative framework does not explicitly consider concentration risk in the
calculation of the capital requirement. However, the ―spreading‖ requirements to some extent
limit the significance of any concentrations.
6.10.4 Conclusions on preferred approach
View 1 ensures that the concentration risk module excludes all assets where the allowance
in the standard formula already reflects that asset‘s specific risk profile and includes all
assets where this is not the case. View 2 exactly replicates EIOPA-DOC-12/467.
7. RECOMMENDATION
7.1 Introduction
The working group did not reach consensus on a number of issues. There are thus three
components to the following recommendations:
1. Recommendations on which there was agreement;
2. Recommendations as per ―view 1‖; and
3. Recommendations as per ―view 2‖.
The recommended text is included in boxes below. The applicable view is specified for each
box, and both views are covered in their entirety. The preamble is applicable to both views.
The South African insurance industry invests in a variety of assets, including
―participations‖. These are companies in which the (re)insurer owns a significant
proportion of the issued share capital or over which it exerts significant influence or
control. This section sets out the treatment of participations for the SAM solo entity
submission This includes their definition and treatment in the balance sheet, own funds
and the solvency capital requirement calculations.
The sections that follow primarily consider the treatment of equity investments in various
classes of participation. Investments in non-equity instruments issued by participations,
e.g. bonds, are not included because they are fixed obligations and less risky. These
should be considered under the relevant market risk modules (e.g. interest rate, credit
spread).
Where the type of instrument is not clear (e.g. hybrid instruments), the general criterion to
apply is as follows: ―If the instrument were not issued by a participation, would it be
considered in the equity risk module?‖:
1. If it would not, then unless specifically discussed below it should be considered under the
relevant market risk module(s) and the discussions below do not apply to it.
2. If it would, then the instrument should be treated as discussed in the sections below.
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7.2 Definition of a participation
The recommendation for the technical definition of a participation is taken from the document
EIOPA-DOC-12/467, and is as follows for both view 1 and view 2:
A participation is constituted by share ownership or by the exertion of a dominant or
significant influence over another undertaking. The following paragraphs describe how
both types of participation can be identified. The identification is based on an
assessment from a solo perspective.
Participations by virtue of share ownership
When identifying a participation based on share ownership, directly or by way of control,
the participating undertaking has to identify:
1. its percentage holding of voting rights and whether this represents at least 20% of the
potential related undertaking‘s voting rights; and
2. its percentage holding of all classes of share capital issued by the related undertaking and
whether this represents at least 20% of the potential related undertaking‘s issued share
capital.
Where the participating undertaking‘s holding represents at least 20% in either case its
investment should be treated as a participation.
Where the participation is in an insurance or reinsurance undertaking subject to SAM,
the assessments under:
–
–
1. above relate to paid-in ordinary share capital included in the Unrestricted Tier 1 Own
Funds, and
2. above relate to paid-in ordinary share capital included in the Unrestricted Tier 1 Own
Funds plus paid-in preference shares.
Participations by virtue of the exertion of dominant or significant influence
When identifying a participation on the basis that the participating undertaking can exert
a dominant or significant influence over another undertaking, the following factors have
to be considered:
1. current shareholdings and potential increases due to the holding of options, warrants or
similar instruments;
2. representation on the administrative, management or supervisory board of the potential
related undertaking;
3. involvement in policy-making processes, including decision making about dividends or other
distributions;
4. material transactions between the participating undertaking and potential related undertaking;
5. interchange of managerial personnel;
6. provision of essential technical information; and
7. membership of a mutual undertaking where that membership is sufficiently large to be nonhomogeneous when compared to that of other members.
Where an undertaking owns a significant portion of the units issued by a unit trust (as
opposed to of the shares of the management company), that unit trust should not be
considered a participation and instead should have a look-through applied.
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7.3 Definition of a financial and credit institution
The following is taken from EIOPA-DOC-12/467 ¶SCR.14.8, but is refined to exclude
explicitly (re)insurance companies. It is applicable for both view 1 and view 2:
A financial and credit institution is an institution listed or described in accordance with the
following paragraphs. Any institution which performs the functions or carries out the
business described pursuant to those paragraphs should be treated as a financial and
credit institution.
A credit institution is
1. an undertaking whose business is to receive deposits or other repayable funds from the public
and to grant credits for its own account; or
2. an electronic money institution, being any legal person which issues means of payment in the
form of electronically-stored claims on the issuer.
A financial institution is an undertaking other than a credit institution, the principal activity
of which is to acquire holdings or to carry on one or more of the activities listed below:
1. Lending including, inter alia: consumer credit, mortgage credit, factoring, with or without
recourse, financing of commercial transactions (including forfeiting);
2. Financial leasing;
3. Money transmission services;
4. Issuing and administering means of payment (e.g. credit cards, travellers' cheques and
bankers' drafts);
5. Guarantees and commitments;
6. Trading for own account or for account of customers in:
a. money market instruments (cheques, bills, certificates of deposit, etc.),
b. foreign exchange,
c. financial futures and options,
d. exchange and interest-rate instruments, or
e. transferable securities;
7. Participation in securities issues and the provision of services related to such issues;
8. Advice to undertakings on capital structure, industrial strategy and related questions and
advice as well as services relating to mergers and the purchase of undertakings;
9. Money broking;
10. Portfolio management and advice; or
11. Safekeeping and administration of securities.
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Any legal person whose regular occupation or business is the provision of one or more of
the following investment services to third parties and/or the performance of one or more
of the following investment activities on a professional basis:
1.
2.
3.
4.
5.
6.
Reception and transmission of orders in relation to one or more financial instruments;
Execution of orders on behalf of clients;
Dealing on own account;
Portfolio management;
Investment advice;
Underwriting of financial instruments and/or placing of financial instruments on a firm
commitment basis;
7. Placing of financial instruments without a firm commitment basis; or
8. Operation of Multilateral Trading Facilities.
Insurance and reinsurance companies are not included within the definition of financial
and credit institutions.
7.4 Principles of valuation for all participations
The recommendation for the valuation of all participations in the solo entity calculation
corresponds to the recommendation in SAM position paper 39 (―Assets and liabilities other
than technical provisions‖) §4.2.7. It is applicable for both view 1 and view 2:
All participations are valued at economic / fair value, whether this is determined using a
mark-to-market or mark-to-model approach. Practically, this is given by
1. an observed market value in a deep and liquid market; or, where this is not available,
2. a market-consistent mark-to-model value based on IFRS fair value principles.
In order to ensure consistency between listed and unlisted participations, additional
disclosures may be required regarding the methodology used to derive mark-to-model fair
values. The relevant SAM task group should consider this and specify an appropriate
recommendation.
7.5 The treatment of participations in financial and credit institutions (F&CIs) in own
funds and the SCR
The recommendation of the working group in respect of F&CIs is discussed in section 6.4.
The working group did not reach consensus. The recommendation of each view is therefore
presented below.
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7.5.1
View 1
Any holdings in instruments available to back capital requirements of a F&CI participation,
other than ordinary share capital, should be deducted in full from own funds.
1. This deduction should occur at a tier of capital corresponding to the tier of capital towards
which the instrument would count if it had been issued by a company regulated under SAM.
This tiering should be determined as per the SAM regulations.
2. The deduction should be calculated allowing for corresponding changes in liabilities. That is,
the value deducted should be the change in the (re)insurer‘s basic own funds arising from a
100% stress to the relevant assets.
3. The assets deducted in this fashion should not be included in the market risk module.
Ordinary share capital issued by F&CI participations may contribute a maximum of 10% of
the (re)insurer‘s Unrestricted Tier 1 Own Funds before deduction.
1. Any amount above 10% should be deducted from Unrestricted Tier 1 Own Funds. Where there
are multiple F&CI participations, the deduction should be pro-rated between them according to
their individual contributions to Unrestricted Tier 1 Own Funds.
2. The deduction should be calculated allowing for corresponding changes in liabilities.
3. Any amount not deducted should be stressed under the relevant market risk sub-module(s).
4. Practically, suppose the threshold is exceeded by x percentage points so that the total holdings
equal x%+10% of Unrestricted Tier 1 Own Funds. Then:
a. The holdings in F&CI participations are reduced by factor f and the liabilities
recalculated. The corresponding change in basic own funds under this scenario is
deducted from Unrestricted Tier 1 Own Funds. f is set such that the excess x% is
removed:
b. The stress applied in the equity risk module is only applied to the holdings in the F&CI
participations remaining after the deduction from Unrestricted Tier 1 Own Funds. So,
where the deduction equals y% of holdings in F&CI participations, the stress in the
equity risk module is only applied to (100–y)% of those holdings.
If a (re)insurer considers the change in liabilities under the deduction to be negligible, it
may apply to the regulator to ignore any reduction in the liabilities. This will result in a
more conservative estimate of the (re)insurer‘s capital position.
Where an F&CI participation does not meet its regulatory capital requirements the
regulator may require an additional deduction from own funds be made.
For the avoidance of doubt, debt instruments not available to back an F&CI participation‘s
capital requirement (e.g. ordinary bonds) are not included in the scope of this section.
The treatment specified above is applicable to all entities classified as F&CI participations,
including those that are not regulated.
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7.5.2
View 2
The treatment of financial and credit institutions should exactly reflect EIOPA-DOC-12/467
(and section SCR14.4 on in Appendix 8.2 in particular).
This would have the own funds reduced by investments (both equity and interest-bearing
investments) in excess of 10% of own funds (before any deductions) per participation as
well as amounts in excess of 10% of own funds (before any deductions) in aggregate for
participations which do not individually constitute more than 10%.
The amounts not deducted would be treated as per any other investment in the SCR,
whereas no capital requirement will be held in respect of amounts deducted.
7.6 The treatment of participations in South African (re)insurance undertakings, i.e.
those regulated under SAM
The working group could not reach consensus regarding the treatment of (re)insurance
participations. The reader is referred to section 6.5 for the discussion of the relevant points.
The final results of the views are presented below.
Additional consideration needs to be given to micro-insurers. The micro-insurer legislation
has not been finalised. It is however recommended that they be treated the same as
(re)insurers.
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7.6.1
View 1
Equity investments in South African (re)insurance participations are to be stressed in a
separate participations risk module that is added to the BSCR, SCRPart.
The stress applicable to each (re)insurance participation will be dependent on that
participation‘s SCR coverage ratio assessed under SAM. The calculation for each
participation i will therefore require the following inputs:
Ai
=
The SAM fair value of (re)insurance participation i, which is the
value at which it is included in the assets.
Fi
=
The SAM own funds of (re)insurance participation i attributable to
the participating (re)insurer.
Ci
=
The SAM SCR of (re)insurance participation i attributable to the
participating (re)insurer.
ei
=
The SAM SA equity, global equity, or other equity stress
percentage, as appropriate to participation i.
The value of ei is determined through the equity risk sub-module. (Re)insurance
participation i should be classified as SA equity, global equity, or other equity as per the
equity risk sub-module and ei set to the applicable equity stress.
The stress applicable to the fair value of (re)insurance participation i (si) is such that the
own funds are stressed by the SCR while the remainder of the fair value is stressed by the
equity stress percentage. The stress is therefore determined through the following
formula:
.
Mathematically this can be simplified to the following:
.
The capital requirement for (re)insurance participations is determined as:
SCRPart = ∆BOF│shock to all (re)insurance participations
where the stress applicable to (re)insurance participation i is si.
The participating (re)insurer should disclose all relevant information relating to its
(re)insurance participations. That is, for each (re)insurance participation i, Ai, Fi, Ci, ei, and si
should be disclosed. This should be considered by the appropriate SAM task group.
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7.6.2
View 2
View 2 follows the same treatment of participations in own funds as View 1, but propose
a different treatment for (re)insurance participations in the SCR. Equity investments in
South African (re)insurance participations are to be stressed in the relevant equity risk
sub-module by the stress percentage applicable in that sub-module. Similar stresses
would apply to interest bearing investments or any other market risk related exposure
(e.g. currency risk) relevant to that participation. This corresponds exactly to the
treatment of (re)insurance participations in Solvency II. This can be referenced in EIOPADOC-12/467 (SCR14.4 in Appendix 8.2).
7.7 The treatment of participations in non-South African (re)insurance undertakings
The reader is referred to section 6.6 for the discussion of the relevant points. The
recommendation for both view 1 and view 2 is as follows:
Non-South African (re)insurance participations should be treated in the same manner as
South African (re)insurance participations.
7.8 The treatment of participations in non-financial undertakings
The issues relating to the treatment of participations in non-financial undertakings are
discussed in section 6.8. The recommendation for both view 1 and view 2 is as follows:
Participations in non-financial undertakings should be treated as ordinary equity
investments, i.e. included in the appropriate equity risk sub-module.
7.9 The treatment of strategic participations in the own funds and SCR
The issues relating to the treatment of strategic participations are discussed in section 6.9.
The recommendation is therefore that no distinction be made between strategic and nonstrategic participations in SAM.
7.10
The treatment of participations in the concentration risk module
The issues relating to the treatment of participations in non-financial undertakings are
discussed in section 6.10. The working group did not reach consensus. The
recommendation of each view is therefore presented below.
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7.10.1 View 1
The concentration risk module reflects the additional risk arising from a non-diversified
portfolio of investments: the 1-in-200-year stress applicable to a single equity is higher
than that applicable to a diversified portfolio. Individual investments will have specific risk
profiles that are not reflected in the standard market risk sub-modules. Participations
should therefore be included in the concentration risk module to the extent that their risk
assessments do not reflect their specific risk.
The following should therefore be excluded from the concentration risk module:
1. Any investments in F&CI participations that are excluded from own funds.
2. Any investments in (re)insurance participations that are considered in the SCRPart module.
All remaining participations should be included in the concentration risk module.
However, when assessing the exposure to a participation for the concentration risk
module, the exposure should be calculated at a legal entity level and not at a group level.
7.10.2 View 2
.
The concentration risk module reflects the additional risk arising from a non-diversified
portfolio of investments: the 1-in-200-year stress applicable to a single equity is higher
than that applicable to a diversified portfolio. Individual investments will have specific risk
profiles that are not reflected in the standard market risk sub-modules. Participations
should therefore be included in the concentration risk module to the extent that their risk
assessments do not reflect their specific risk.
The following should therefore be excluded from the concentration risk module:
1. Any investments in F&CI participations that are excluded from own funds.
2. Any investments in (re)insurance participations that are considered in the SCRPart module.
All remaining participations should be included in the concentration risk module.
However, when assessing the exposure to a participation for the concentration risk
module, the exposure should be calculated at a legal entity level and not at a group level.
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8. APPENDICES
8.1 DEFINITION OF FINANCIAL AND CREDIT INSTITUTION
EIOPA-DOC-12/467 ¶SCR.14.8 defines financial and credit institutions as:
–
―[A]n institution listed or described in accordance with Article 4(1) and (5) of Directive 2006/48/EC
or Article 4(1) of Directive 2004/39/EC. Any institution which performs the functions or carries out
the business described pursuant to those Articles should be treated as a financial and credit
institution notwithstanding that it may not be subject to the Directives, either because it is a third
country undertaking or otherwise out of scope.‖
Directive 2006/48/EC:
–
–
–
Article 4(1):
(1) ―‗credit institution‘ means:
(a) an undertaking whose business is to receive deposits or other repayable funds
from the public and to grant credits for its own account; or
(b) an electronic money institution within the meaning of Directive 2000/46/EC (1);‖
Article 4(5):
(5) ―‗financial institution‘ means an undertaking other than a credit institution, the principal
activity of which is to acquire holdings or to carry on one or more of the activities listed in
points 2 to 12 of Annex I;‖
Annex I:
2. ―Lending including, inter alia: consumer credit, mortgage credit, factoring, with or without
recourse, financing of commercial transactions (including forfeiting)
3. Financial leasing
4. Money transmission services
5. Issuing and administering means of payment (e.g. credit cards, travellers' cheques and
bankers' drafts)
6. Guarantees and commitments
7. Trading for own account or for account of customers in:
(a) money market instruments (cheques, bills, certificates of deposit, etc.);
(b) foreign exchange;
(c) financial futures and options;
(d) exchange and interest‑rate instruments; or
(e) transferable securities.
8. Participation in securities issues and the provision of services related to such issues
9. Advice to undertakings on capital structure, industrial strategy and related questions and
advice as well as services relating to mergers and the purchase of undertakings
10. Money broking
11. Portfolio management and advice
12. Safekeeping and administration of securities‖
Directive 2004/39/EC:
–
Article 4(1):
(1) ―For the purposes of this Directive, the following definitions shall apply:
1) ‗Investment firm‘ means any legal person whose regular occupation or business is the
provision of one or more investment services to third parties and/or the performance
of one or more investment activities on a professional basis;
Member States may include in the definition of investment firms undertakings which
are not legal persons, provided that:
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(a)
(b)
their legal status ensures a level of protection for third parties' interests
equivalent to that afforded by legal persons, and
they are subject to equivalent prudential supervision appropriate to their legal
form.
However, where a natural person provides services involving the holding of third
parties' funds or transferable securities, he may be considered as an investment firm
for the purposes of this Directive only if, without prejudice to the other requirements
imposed in this Directive and in Directive 93/6/EEC, he complies with the following
conditions:
(a)
the ownership rights of third parties in instruments and funds must be
safeguarded, especially in the event of the insolvency of the firm or of its
proprietors, seizure, set-off or any other action by creditors of the firm or of its
proprietors;
(b)
the firm must be subject to rules designed to monitor the firm's solvency and
that of its proprietors;
(c)
the firm's annual accounts must be audited by one or more persons
empowered, under national law, to audit accounts;
(d)
where the firm has only one proprietor, he must make provision for the
protection of investors in the event of the firm's cessation of business following
his death, his incapacity or any other such event;
2) ‗Investment services and activities‘ means any of the services and activities listed in
Section A of Annex I relating to any of the instruments listed in Section C of Annex I;
The Commission shall determine, acting in accordance with the procedure referred to
in Article 64(2):
— the derivative contracts mentioned in Section C 7 of Annex I that have the
characteristics of other derivative financial instruments, having regard to whether,
inter alia, they are cleared and settled through recognised clearing houses or are
subject to regular margin calls
— the derivative contracts mentioned in Section C 10 of Annex I that have the
characteristics of other derivative financial instruments, having regard to whether,
inter alia, they are traded on a regulated market or an MTF, are cleared and settled
through recognised clearing houses or are subject to regular margin calls;
–
–
… [the remaining paragraphs are not relevant]‖
Annex I Section A: Investment services and activities
(1) ―Reception and transmission of orders in relation to one or more financial instruments.
(2) Execution of orders on behalf of clients.
(3) Dealing on own account.
(4) Portfolio management.
(5) Investment advice.
(6) Underwriting of financial instruments and/or placing of financial instruments on a firm
commitment basis.
(7) Placing of financial instruments without a firm commitment basis
(8) Operation of Multilateral Trading Facilities‖
Annex I Section C: Financial Instruments
(1) ―Transferable securities;
(2) Money-market instruments;
(3) Units in collective investment undertakings;
(4) Options, futures, swaps, forward rate agreements and any other derivative contracts
relating to securities, currencies, interest rates or yields, or other derivatives instruments,
financial indices or financial measures which may be settled physically or in cash;
(5) Options, futures, swaps, forward rate agreements and any other derivative contracts
relating to commodities that must be settled in cash or may be settled in cash at the
option of one of the parties (otherwise than by reason of a default or other termination
event);
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(6) Options, futures, swaps, and any other derivative contract relating to commodities that
can be physically settled provided that they are traded on a regulated market and/or an
MTF;
(7) Options, futures, swaps, forwards and any other derivative contracts relating to
commodities, that can be physically settled not otherwise mentioned in C.6 and not being
for commercial purposes, which have the characteristics of other derivative financial
instruments, having regard to whether, inter alia, they are cleared and settled through
recognised clearing houses or are subject to regular margin calls;
(8) Derivative instruments for the transfer of credit risk;
(9) Financial contracts for differences.
(10) Options, futures, swaps, forward rate agreements and any other derivative contracts
relating to climatic variables, freight rates, emission allowances or inflation rates or other
official economic statistics that must be settled in cash or may be settled in cash at the
option of one of the parties (otherwise than by reason of a default or other termination
event), as well as any other derivative contracts relating to assets, rights, obligations,
indices and measures not otherwise mentioned in this Section, which have the
characteristics of other derivative financial instruments, having regard to whether, inter
alia, they are traded on a regulated market or an MTF, are cleared and settled through
recognised clearing houses or are subject to regular margin calls.‖
Directive 2000/46/EC:
–
Article 1(3)
(1) The term ―‗electronic money institution‘ shall mean an undertaking or any other legal
person, other than a credit institution as defined in Article 1, point 1, first subparagraph (a)
of Directive 2000/12/EC which issues means of payment in the form of electronic money‖.
(2) The term ―‗electronic money‘ shall mean monetary value as represented by a claim on the
issuer which is:
 (i) stored on an electronic device;
 (ii) issued on receipt of funds of an amount not less in value than the monetary
value issued;
 (iii) accepted as means of payment by undertakings other than the issuer.‖
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8.2 Treatment of solo participations as per EIOPA-DOC-12/467
SCR.14. Solo treatments of participations
SCR.14.1 Introduction
SCR.14.1
The intention of this section is to provide an overview of the treatment of
participations in each area of these technical specifications.
SCR 14.2
Once a participation has been identified in accordance with subsection
SCR.14.2., the treatment of equity investments in that related
undertaking, value in accordance with subsection SCR.14.3., and of any
other own-fund items, held in that related undertaking by the participating
undertaking is provided in Annex V. The subsections SCR.14.4. to
SCR.14.6. provide additional guidance.
SCR14.2.
Characteristics of a participation
SCR.14.3.
A participation is constituted by share ownership or by the exertion of a
dominant or significant influence over another undertaking. The following
paragraphs describe how both types of participation can be identified.
SCR.14.4.
The identification is based on an assessment from a solo perspective.
SCR.14.2.1
Participations by virtue of share ownership
SCR.14.5.
When identifying a participation based on share ownership, directly or by
way of control, the participating undertaking has to identify
(i)
(ii)
Its percentage holding of voting rights and whether this represents at
least 20% of the potential related undertaking‘s voting rights and
Its percentage holding of all classes of share capital issued by the
related undertaking and whether this represents at least 20% of the
potential related undertaking‘s issued share capital.
Where the participating undertaking‘s holding represents at least 20% in
either case its investment should be treated as a participation.
SCR.14.6.
SCR.14.2.2
influence
SCR.14.7.
Where the participation is in an insurance or reinsurance undertaking
subject to Solvency II, the assessments under SCR.14.4. (i) relate to
paid-in ordinary share capital referred to in OF.4. (i) and under SCR.14.4.
(ii), to paid-in ordinary share capital referred to in OF.4. (i) and paid-in
preference shares.
Participations by virtue of the exertion of dominant or significant
When identifying a participation pursuant to Article 212 (2) of Directive
2009/138/EC on the basis that the participating undertaking can exert a
dominant or significant influence over another undertaking, the following
factors have to be considered:
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(i)
(ii)
(iii)
(iv)
(v)
(vi)
(vii)
SCR.14.2.3.
Current shareholdings and potential increases due to the holding of
options, warrants or similar instruments
Representation on the administrative, management or supervisory board
of the potential related undertaking
Involvement in policy-making processes, including decision making
about dividends or other distributions
Material transactions between the participating undertaking and potential
related undertaking
Interchange of managerial personnel
Provision of essential technical information
Membership of a mutual undertaking where that membership is
sufficiently large to be non-homogeneous when compared to that of
other members
Participations in financial and credit institutions
SCR.13.8.
Undertakings should treat a related undertaking as a financial and credit
institution, where it is an institution listed or described in accordance with
Article 4(1) and (5) of Directive 2006/48/EC or Article 4(1) of Directive
2004/39/EC. Any institution which performs the functions or carries out
the business described pursuant to those Articles should be treated as a
financial and credit institution notwithstanding that it may not be subject
to the Directives, either because it is a third country undertaking or
otherwise out of scope.
SCR.14.9.
Any participation in a financial and credit institution held indirectly is
treated in the same way as a directly held participation in a financial and
credit institution.
SCR.14.2.4.
Strategic participations
SCR.14.10.
met:
An equity investment is of a strategic nature if the following criteria are
(i)
(ii)
The value of the equity investment is likely to be materially less volatile
for the following 12 months than the value of other equities over the
same period as a result of both the nature of the investment and the
influence exercised by the participating undertaking in the related
undertaking.
The nature of the investment is strategic, taking into account all relevant
factors, including:
a. The existence of a clear decisive strategy to continue holding the
participation for long period
b. The consistency of the strategy referred to in point (a) with the main
policies guiding or limiting the actions of the undertaking
c. The participating undertaking‘s ability to continue holding the
participation in the related undertaking
d. The existence of a durable link
e. Where the insurance or reinsurance participating company is part of
a group, the consistency of such strategy with the main policies
guiding or limiting the actions of the group
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Discussion Document 53 (v 10) – Treatment of participations in the solo entity submission under SAM
SCR.14.3.
Valuation
SCR.14.11.
The valuation of participations for the purposes of the Quantitative
Assessment is set out in V.8.
SCR.14.4.
Treatment of participations, other than in financial and credit
institutions, in the calculation of the Solvency Capital Requirement
with the Standard Formula
SCR.14.12.
The calculation of the Solvency Capital Requirement in accordance with
the standard formula for participations in undertakings other than
financial and credit institutions, does not require the aggregation of the
investment in own funds items in respect of each participation. The
equity risk charge relevant to the investment in ordinary or preference
share capital of the related undertakings is determined independently
from the application of the relevant risk charges (e.g. interest, spread,
concentration, currency) to any investment in subordinated liabilities of
the related undertaking, which is treated as a bond.
SCR.14.13.
When applying the standard formula to the equity and subordinated
liability components of a participation, the undertaking has to:
(i)
(ii)
(iii)
Apply the interest and spread risk sub-modules set out in subsection
SCR.5.5. and SCR.5.9. relevant to bonds to holding of subordinated
liabilities
Apply the relevant equity risk charges to equity holdings as set out in
subsection SCR.5.6.
Apply additional market risk sub-modules, such as currency, as
appropriate
SCR.14.4.
Treatment of participations in financial and credit institutions in the
calculation of Own Funds
SCR.14.14.
When calculating the value of a participation, in order to assess whether
the deductions set out in SCR.14.16. or SCR.14.17. apply, the
undertaking has to consider holdings of both equity and any other ownfund items held in the related undertaking by the participating
undertaking.
SCR.14.15.
The deductions and other treatments in respect of financial and credit
institutions are set out in Annex V.
SCR.14.16.
The basic own funds have to be reduced by the full value of each
participation in a financial and credit institution that exceeds 10% of items
listed in OF.4.
SCR.14.17.
The basic own funds have to be reduced by the part of the aggregate
value of all participations in financial and credit institutions, other than
participations dealt with under SCR.14.16., that exceeds 10% of items
listed in points OF.4.
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Discussion Document 53 (v 10) – Treatment of participations in the solo entity submission under SAM
SCR.14.18.
In calculating the 10% of items listed in OF.4. the amount of own-funds
items before any deduction set out in SCR.14.16. or SCR.14.17. is used.
SCR.14.19.
Notwithstanding, SCR.14.16. and SCR.14.17., there is no deduction for
strategic participations which are included in the calculation of the group
solvency on the basis of method 1 as described in subsection G.1.1.
SCR.14.20.
Deductions according to SCR.14.17. are applied on a pro-rata basis to all
participations referred to in that paragraph.
SCR.14.21.
Deductions included in paragraphs SCR.14.16. and SCR.14.17. are
made from the corresponding tier in which the participation has increased
the own funds of the related undertaking as follows:
(i)
(ii)
(iii)
Holdings of Common Equity Tier 1 items of financial and credit
institutions have to be deducted from the items listed in OF.4.
Holdings of Additional Tier 1 instruments of financial and credit
institutions have to be deducted from the items listed in OF.39.
Holdings of Tier 2 instruments of financial and credit institutions have to
be deducted from the items listed in OF.40.
SCR.14.22.
Where the items to be deducted are not classified into tiers, all
deductions are made from the amount of items listed in OF.4.
SCR.14.23.
Where the amount of the deduction exceeds the amount from which it is
required to be deducted in accordance with SCR.14.21., the excess is
deducted from higher quality items until the deduction is made in full.
SCR.14.24.
In the calculation of the Solvency Capital Requirements amounts not
deducted should be treated in accordance with subsection 14.6. when an
internal model is used and section SCR.5. when the standard formula is
applied.
SCR.14.5.
Treatment of participations in the calculation of the Solvency
Capital Requirement with an internal model
SCR.14.25.
the requirements set out in subsection SCR.14.5. apply to firms using
internal models in so far as any reduction of own funds set out in
subsection SCR.14.5. for holdings in financial and credit institutions has
to be made. The treatment of holdings in financial and credit institutions
not deducted in whole or part has to ensure that the requirements set out
in Article 103 (3) of Directive 2009/138/EC are met
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Discussion Document 53 (v 10) – Treatment of participations in the solo entity submission under SAM
8.3 Comparison of methods of incorporating a participation’s risk
The example below illustrates how adding the risk on a participation to the parent‘s SCR
results in a more appropriate SCR coverage ratio for the parent than deducting the risk from
the parent‘s own funds. It relates to section 6.5.2.2. The approaches referenced herein relate
to the approaches in that section.
Consider the following example:
–
–
–
–
The participating (re)insurer has own funds excluding the participation of R50mn and an SCR of
R40mn.
The fair value of the participation is R50mn.
The appropriate risk charge to the fair value of the participation is 50% of its fair value, i.e.
R25mn.
Approach 2 adds the participation‘s SCR to the participating (re)insurer‘s; approach 3 deducts the
participation‘s SCR from the participating (re)insurer‘s own funds.
The coverage ratios under the two approaches for the participating (re)insurer are as follows.
Included are the ratios where the participating (re)insurer does not have the participation and
that where the participation has been consolidated (assuming the consolidated position uses
fair value with the associated risk charge and that there is no diversification benefit):
No participation
Approach 2
Approach 3
Consolidated
Own funds (R‘mn)
50
100
75
100
SCR (R‘mn)
40
65
40
65
Capital coverage (x)
1.25
1.53
1.88
1.53
So, while the excess of own funds over the SCR is appropriate under both approaches
(R35mn), under Approach 3 the SCR understates the true level of risk and hence the capital
coverage ratio is inappropriate.
As a result, Approach 3 allows (re)insurers to manipulate their capital coverage ratios
through changing their corporate structures without changing their risk profiles. Consider the
following example:
–
–
A (re)insurer has own funds of R100mn and an SCR of R50mn (capital coverage ratio of 2x).
It transfers R30mn of SCR (risk) to a participation, along with R40mn of own funds to back that
SCR. It now has a capital coverage ratio of 60/20 = 3x. This improvement is not due to an
improved risk position.
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Discussion Document 53 (v 10) – Treatment of participations in the solo entity submission under SAM
8.4 SA QIS2 Investigations
A workbook was developed to assess the possible impact of a variety of treatments of South
African (re)insurance participations. This was based on the results and methodology from
the SA QIS2 exercise. Section 6.5.2.1 considers two key components of the treatment of
(re)insurance participations: the appropriate level of diversification included in the standard
formula and the appropriate stress percentage to be used.
8.4.1
The appropriate level of diversification
a. The workbook assessed the SA QIS2 position of an average life and non-life insurer (separately)
under the following treatments of (re)insurance participations:
i.
Accounting consolidation method (taken to be representative of the true risk position,
although this ignores issues with the transferability of capital, since it accurately assesses
the combined risk profile of the two entities);
ii.
SA QIS1 treatment (included as equity in the equity risk sub-module); and
iii.
SA QIS2 treatment (included in a separate participations module (outside the BSCR
calculation), but attracting equity risk capital charges).
b. Six cases were considered:
i.
A life insurer participating in a life insurer;
ii.
A life insurer participating in a non-life insurer;
iii.
A life insurer participating in a joint life/non-life insurer (50–50 split);
iv.
A non-life insurer participating in a life insurer;
v.
A non-life insurer participating in a non-life insurer; and
vi.
A non-life insurer participating in a joint life/non-life insurer (50–50 split).
c. The following key assumptions were made:
i.
As (re)insurance participations were valued at fair value in the solo submissions, an
assumption was needed regarding the split of the two elements of an insurance fair value
(own funds and WTFV). The fair value of life insurance participations was assumed to be
90% own funds and 10% WTFV. For non-life insurance participations the split was
assumed to be 15% own funds and 85% WTFV. These splits are based on the discussion
in section 6.5.2.1 point 1.
ii.
The risk profiles of participations corresponded to a weighted average of their own funds
and WTFV.
1. The risk profile of own funds was assumed to follow the average SCR risk profile from
the SA QIS2 exercise, separately for life and non-life participations.
2. The risk profile of WTFV was assumed to follow 50% equity risk and 50%
underwriting risk.
iii.
The size of the SA QIS2 delta-BOF stress for participations was assumed to equal the
correct delta-BOF stress allowing for the underlying risk profile.
d. The results are presented below. The percentages in the second and fourth columns compare the
results under the SA QIS1 and SA QIS2 approaches to the accounting consolidation approach
(which is taken to represent the true risk position). Note that these are merely indicative. A
positive number suggests that the approximation (i.e. SA QIS1 or SA QIS2) overstates the ―true‖
capital requirement and vice versa.
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Discussion Document 53 (v 10) – Treatment of participations in the solo entity submission under SAM
Type of participation
1. Life company
Calculation method
Accounting consolidation
SA QIS2
2. Non-life company
SA QIS1
Accounting consolidation
SA QIS2
3. Equal mix life and
non-life
SA QIS1
Accounting consolidation
SA QIS2
SA QIS1
Type of participating entity
Life insurer
Non-life insurer
100.00
100.00
100.03
108.84
0.03%
8.84%
95.43
103.73
–4.57%
3.73%
100.00
107.59
102.64
100.00
101.40
96.73
7.59%
2.64%
1.40%
–3.27%
100.00
100.40
95.68
100.00
102.69
97.86
0.40%
–4.32%
2.69%
–2.14%
Table 8.4.1-1: Estimated SCR under various methodologies
e. The table above suggests that:
i.
Where a (re)insurer holds a participation writing similar risks, the SA QIS1 methodology
understates the risk relative to the accounting consolidation method, while the SA QIS2
methodology is fairly accurate. This is because the SA QIS1 treatment overstates the
diversification benefits that are assumed to exist.
ii.
Where a (re)insurer holds a participation writing different risks, both the SA QIS1 and
SA QIS2 methodologies overstate the risk relative to the accounting consolidation
method, although SA QIS1 less so. This is because the diversification benefits of
introducing, for example, non-life risks to an insurer exposed mainly to life and market
risks are greater than those obtained by only increasing the market risk (SA QIS1) or by
assuming no diversification benefit (SA QIS2).
iii.
Where the participation is a split between a life and non-life insurer, the SA QIS1
methodology understates the risk while the SA QIS2 methodology overstates it, for similar
reasons as those above.
f. The results and discussion in d and e above relate to the structure of the standard formula re
participations, i.e. how best to estimate the diversification benefits within the constraints of a
standard formula.
g. In addition to the above, more detailed SA QIS2 participation data were requested from the FSB.
The purpose of this request was to assess more accurately the nature of participations in other
insurers.
i.
The following were provided for each (re)insurer in SA QIS2:
1. The nature of the (re)insurer (life vs non-life); and
2. The ratio of the fair value of participations to the participating (re)insurer‘s BSCR, split
by life, non-life, and other.
ii.
Only (re)insurers with reasonably large (re)insurance participations were considered. This
was assessed by considering the ratios above after applying the SA QIS2 SA equity
stress (47%). Where the post-stress ratio exceeded 2.5% the (re)insurer was included in
the analysis. Ten (re)insurers were therefore included.
iii.
These ten participating (re)insurers were then categorised into the six cases considered
above. The numbers are presented in the table below:
Type of
participation
Life
Non-life
Mixed
Life
Non-life
insurer insurer
4
0
1
4
1
0
Table 8.4.1-2: Nature of insurance participations
i.
The table above provides high-level insights into intra-sector participations in the South
African insurance sector. In particular, where a South African (re)insurance company
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Discussion Document 53 (v 10) – Treatment of participations in the solo entity submission under SAM
ii.
8.4.2
holds a (re)insurance participation, it is likely to hold a participation writing the same class
(life vs non-life) of business.
This suggests that it may be appropriate primarily to consider the likely diversification
between life companies or non-life companies when determining the simplification used to
assess the risk in (re)insurance participations.
The appropriate stress percentage
a. For both SA QIS1 and SA QIS2, the stress applied to the fair value of the (re)insurance
participation was the equity risk stress. For South African listed (re)insurance participations this
was 47% (after symmetric adjustment); for unlisted (re)insurance participations it was 53%.
b. Calculations were performed in order to assess the appropriateness of these stresses. (The
stresses make implicit assumptions regarding the split of fair value between own funds and
WTFV, the SCR coverage ratio, and the behaviour of WTFV in stress scenarios.)
c. The following assumptions were made in these calculations:
i.
As above, WTFV constitutes 10% of the fair value of life insurance participations and 85%
of non-life participations. These splits are based on the discussion in section 6.5.2.1
point 1.
ii.
The percentage stress to own funds was taken to be the average ratio of SCR to own
funds in SA QIS2 (determined separately for life and non-life insurers). Sensitivities of
+50% and –50% to the SCR were performed. The average coverage ratio under SA QIS2
for life insurers was 1.72x (stress of 58.11%). That for non-life insurers was 1.49x (stress
of 67.15%).
iii.
The percentage stress to WTFV was taken as the average of half the percentage stress
to own funds (including sensitivity) and the SA QIS2 SA equity stress after symmetric
adjustment (47%). This was felt to be reasonable since (in line with section 6.5.2.1 point 3
above):
1. The weighting towards equity risk reflects the sensitivity of WTFV to equity market
factors, e.g. the state of the economy and market sentiment.
2. The weighting towards the SCR reflects the sensitivity of WTFV to company-specific
factors. The scaling of the own funds stress reflects that the WTFV is likely to be less
sensitive to company-specific risks affecting in-force business than own funds. For
example, suppose the appropriate stress in year one is 5% of the SCR, but affects
the profitability of new business for ten years. The reduction in WTFV is then 50% of
the SCR.
d. The results are presented below:
Type of participating entity
Life insurer
Base case
+50% Sensitivity
–50% Sensitivity
Own
funds
Component stress
58.11%
Implied fair value stress
56.11%
Component stress
87.17%
Implied fair value stress
Component stress
82.98%
29.06%
Implied fair value stress
29.23%
Non-life insurer
WTFV
Own
funds
WTFV
38.03%
67.15%
40.29%
44.32%
45.29%
100.73%
48.68%
30.76%
56.49%
33.58%
31.89%
32.15%
Table 8.4.2-1: Estimated implied participations stress under various assumptions
e. The table above shows that the appropriate stress to apply to the fair value (based on the
assumptions above) varies significantly depending on the SCR coverage of the participation. This
is particularly the case for life insurers, since their own funds are assumed to constitute 90% of
their fair value.
f. Two additional items of data were received from the FSB relating to participations in particular:
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Discussion Document 53 (v 10) – Treatment of participations in the solo entity submission under SAM
i.
The SCR coverage ratio of life and non-life participations, and
ii.
The approximate ratio of fair value to own funds for life and non-life participations.
These were used to assess whether some of the assumptions above were appropriate.
g. The average SCR coverage ratio for life participations was 1.56x (stress to own funds of 64.29%).
That for non-life participations was 1.44x (stress to own funds of 69.40%). These indicate that the
solvency position of participations is marginally worse than that for the industry as a whole.
h. The average ratio of fair value to own funds was requested on three bases relating to different
levels of own funds (basic, pre-eligibility, post-eligibility). There were six life insurance
participations and seven non-life insurance participations (although two of these were discarded
as the FSB highlighted potential issues with them).
i.
The average ratio of assessed fair value to own funds was 1.20x for life insurance
participations and 1.32x for non-life participations.
ii.
This implies that the assumed WTFV of life insurers is marginally understated at 10%,
while that of non-life insurers is significantly overstated at 85%.
iii.
However, for the SA QIS2 exercise, fair value was assessed as one of four values:
1. ―Current accounting basis value‖;
2. ―Market value from quoted active markets‖;
3. ―Adjusted equity method‖; and
4. ―Marked to model‖.
Thus it is reasonable to assume that the assessed fair value under SA QIS2 was not
necessarily the true fair value as considered in this discussion document. This is because
(re)insurers were able to use non-fair value measures, e.g. the current accounting basis
for life insurers.
iv.
Given this, the assumptions regarding the proportion of fair value made up by the WTFV
were not revised.
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