Solvency II

The Solvency II regime introduces for the first time a harmonized, sound and robust prudential framework for insurance firms in the European Union (EU). It is based on the risk profile of each individual insurance company in order to promote comparability and transparency. Take a look at our Solvency II infographic (pdf) for a quick overview. 

We report our Solvency II position for our holding company twice a year in our half year results press release. Visit our results page for the latest update.

Over its 40 years of existence, the Solvency I regime showed structural weaknesses. Solvency I was not risk-sensitive, and a number of key risks, including market, credit and operational risks were either not captured at all in capital requirements or were not properly taken into account in the one-model-fits-all approach.

Under Solvency II, capital requirements are forward-looking and economic, i.e. they will be tailored to the specific risks born by each insurer, allowing an optimal allocation of capital across the business. The capital requirements are defined by a two-step ladder, including the solvency capital requirements (SCR) and the minimum capital requirements (MCR), in order to trigger proportionate and timely supervisory intervention.

Additionally, Solvency II will eliminate existing restrictions imposed by EU Member States on the composition of an insurers' investment portfolio. Instead, insurers will be free to invest according to the 'prudent person principle' and capital requirements will depend on the actual risk of investments.

The Solvency II rules examine how much risk an insurer is exposed to, and uses this to determine the amount of capital they need to hold. Risk is determined by the type of business an insurer writes, the way they manage their risks and how strong their risk management framework is.

All European Union (EU) insurance firms must prove they have enough capital to survive a one-in-200-year shock(s), and still be able to meet policyholder obligations.

Aegon's existing economic model for managing risk (its Economic Framework) and its Enterprise Risk Management Framework (ERM) formed a strong basis on which to develop its partial internal model. The various components of the internal model were extensively debated with the relevant supervisors, went through internal governance and were fully validated and vetted before approval was obtained. Furthermore, Solvency II has been embedded within the ERM Framework, risk tolerances, risk policies and standards, and practices.

Aegon's main risks include underwriting risk, credit risk, equity market risk, interest rate risk and currency exchange rate risk.

Pillar I: Capital Requirements

This pillar covers insurance balance sheets, which are based on liabilities, assets and an amount of capital needed to ensure that claims can be paid with a high likelihood. Pillar 1 of Solvency II requires businesses to calculate their Solvency Capital Requirement (SCR), using either the Standard Formula (determined by EIOPA, the European insurance regulator) or a (Partial) Internal Model (calibrated by the insurance company and approved by the insurers' regulator). The Minimum Capital Requirement (MCR) must also be calculated. This is the figure below which the regulator would intervene to protect policyholders.

Pillar II: Governance & Supervision

This pillar covers the structure and management of insurance businesses and how they are governed. It requires insurers to identify, measure, monitor, manage and report risks they are exposed to. Insurers must put risk management at the heart of decision-making, and are required to conduct an Own Risk and Solvency Assessment (ORSA).

Pillar III: Reporting & Disclosure

Involves how aspects of Solvency II are reported to supervisors and the external stakeholders. This pillar covers the supervisory reporting and public disclosure of financial and other information by insurance companies.

The main benefits the European regulators are aiming to achieve from Solvency II include:

Improved industry standards of risk management.
Improved transparency of risk reporting; this will give rating agencies, policyholders, brokers, and investors a better understanding of how insurance companies are run, the risks they take, how they allocate their capital and how risks are managed.
Better protection for customers, reducing the chance of an insurer failing because the capital it holds should better reflect the risks facing it.
Efficient allocation of capital across the industry; this will be reflected in reduced costs for consumers.
Increased competition, imposed on insurance companies, will lead to improved product development and pricing.

Under Solvency II, capital requirements can be calculated: (i) on the basis of an internal model, developed by the insurance company itself, which requires the approval of the supervisor; (ii) on the basis of a standard formula, in accordance with Solvency II rules and guidelines; or (iii) a combination of an internal model and the standard formula, a partial internal model.

An important development in 2015 was that Aegon both applied for and received approval to use a partial internal model as of January 1, 2016, to measure and aggregate the risks related to its exposures in the European Economic Area (EEA) and calculate its Solvency Capital Required (SCR) under Solvency II. A standard formula is used for certain less material risks in the Netherlands and the UK, and all risks in other business units.

The standard model is a more simplistic calculation with more prescribed (rather than company developed) parameters. Each insurance company is given the factors and formulas they have to use without flexibility.

The Internal Model is a risk management system developed by an individual insurer. Since this deviates from the Standard Formula, it needs to be approved by the regulator before it can be used. By using an Internal Model, insurers are be able to better describe their own risks and thus treat them more appropriately than under the Standard Formula.

The partial internal model is a hybrid of the Standard Formula and Internal Model. For Aegon, we apply a partial internal model in the Netherlands and United Kingdom, which means that we use certain elements from the Standard Formula along with our own unique to Aegon approved risk assumptions to derive our Solvency II ratio.

In order to ensure a level playing field, Aegon does not apply Solvency II to its businesses in the United States. The US regulatory system has been granted equivalence under Solvency II, meaning that the US continues to calculate its capital position as it has always done and this capital, after conversion into a Solvency II equivalent number, is added to the European numbers for Aegon Group reporting purposes.

The US Risk Based Capital (RBC) framework is accepted by the Group regulator to be equivalent at 150% RBC after reducing own funds by 100% RBC requirement to reflect transferability restrictions.

Aegon will disclose its group Solvency II position each quarter as part of the quarterly results disclosures. Solvency II ratios per business unit will be reported on a semi-annual basis. Results overview page >

Aegon has been working over the past several years to focus the business and to divest businesses deemed non-core. The non-core businesses have been divested for strategic rationales and to continue to optimize the Aegon portfolio of businesses.

The Ultimate Forward Rate (UFR) is a method to build a risk free curve from market rates up to the Last Liquid Point (LLP) and then extrapolate to a fixed (forward) rate for longer maturities.

The UFR was designed to extrapolate the risk free curve beyond the traded maturities in liquid markets up to the convergence point, where rates converge towards the UFR. The convergence point is a function of the currency and corresponds to the LLP plus 40 years. For the Euro (currency) the convergence point is 60 years based on the LLP of 20 years.

The UFR is currently fixed at 4.2%. The UFR of 4.2% does not mean that liabilities are discounted at 4.2% immediately at year 60, rather, the risk free curve grades over time to 4.2% at a point in time beyond year 100.

EIOPA, the European insurance authority, has recently proposed to reduce the UFR by 55 bps to 3.65% by year 2020 in three steps of maximum 15 bps starting in 2018.

Our target Solvency II ratio ranges are:
Aegon Group: 150-200%
Aegon the Netherlands: 150-190%
Aegon UK: 145-185%