August 23, 2013
Milliman Report
Report of the Independent Expert on the proposed transfer of the insurance business of certain of the European branches of Mitsui Sumitomo Insurance Company (Europe) Limited to MSIG Insurance Europe AG
Prepared for: Mitsui Sumitomo Insurance Company (Europe) Limited MSIG Insurance Europe AG
Prepared by: Gary Wells FIA
11 Old Jewry London, EC2R 8DU United Kingdom Tel +44 (0)20 7847 1500 Fax +44 (0)20 7847 1501 milliman.co.uk
Milliman Report
Report of the Independent Expert on the proposed transfer of the insurance business of certain of the branches of MSIEu to MSIG AG
August 23, 2013
CONTENTS
1. Introduction .................................................................................................................................................... 1
2. Regulatory Background ................................................................................................................................. 5
3. Background on MSIEu ................................................................................................................................. 12
4. Background on MSIG AG ............................................................................................................................ 17
5. The proposed Scheme ................................................................................................................................ 20
6. General Considerations of the Independent Expert ..................................................................................... 25
7. The Effect of the Scheme on the Transferring Policyholders ....................................................................... 27
8. The Impact of the Scheme on the Remaining Policyholders of MSIEu ........................................................ 54
9. The Impact of the Scheme on the Current MSIG AG Policyholders ............................................................ 56
10. Other Considerations ................................................................................................................................... 58
11. Conclusions ................................................................................................................................................. 69
APPENDIX 1. Defined Terms.......................................................................................................................... 70
APPENDIX 2. List of Previous Transfers for which I have Acted as the Independent Expert or Equivalent .... 71
APPENDIX 3. Extract of the Scope of the work of the Independent Expert in relation to the Scheme ............ 72
APPENDIX 4. Key Sources of Data ................................................................................................................ 73
APPENDIX 5. Minimum Capital Requirement ................................................................................................. 74
APPENDIX 6. MaRisk (VA) ............................................................................................................................. 76
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Report of the Independent Expert on the proposed transfer of the insurance business of certain of the branches of MSIEu to MSIG AG
August 23, 2013 1
1. INTRODUCTION
Purpose of Report
1.1. It is proposed that the insurance business of certain of the European branches of Mitsui Sumitomo Insurance
Company (Europe) Limited (“MSIEu”) be transferred to MSIG Insurance Europe AG (“MSIG AG”) by an
insurance business transfer scheme (the “Scheme”) as defined in Section 105 of the Financial Services and
Markets Act 2000 (“FSMA”).
1.2. A list of terms defined in this report is shown in Appendix 1. Otherwise I use the same defined terms as are
in the Scheme.
1.3. Section 109 of FSMA requires that an application to the High Court of Justice in England and Wales (“the
Court”) for an order sanctioning an insurance business transfer scheme must be accompanied by a report on
the terms of the scheme (the “Report”) by an independent person having the skills necessary to make the
report and who is nominated or approved by the Prudential Regulation Authority (“PRA”) and the Financial
Conduct Authority (“FCA”). The Report is required in order that the Court may properly assess the impact of
the proposed transfer, including the effect on policyholders of the insurance companies in question. MSIEu
has nominated me to act as an independent expert to provide the Report and the PRA has approved my
appointment (see paragraph 1.9 below).
1.4. This Report describes the proposed transfer and discusses its possible effects on the policyholders of
MSIEu and MSIG AG, including effects on security and levels of service.
The Proposed Scheme
1.5. The business to be transferred under the Scheme consists of contracts of (re)insurance written and issued
by MSIEu in support of the (re)insurance business conducted through the continental European branches of
MSIEu (the “Transferred Business”).
1.6. Certain non-insurance assets comprising the business of MSIEu were transferred to MSIG AG on 1
December 2012, pursuant to the terms of a Business Transfer Agreement entered into between MSIEu and
MSIG AG of the same date (the “BTA”). I have been informed that the BTA may need amending to reflect
changes to the provisions for transfer of employees from MSIEu to MSIG AG.
1.7. The Effective Date of the transfer is expected to be 31 December 2013. The transfer under the Scheme (the
“Transfer”) is intended to have the effect that all the liabilities under the policies comprising the Transferred
Business, and appropriate assets (including reinsurance), will pass under the Scheme to MSIG AG.
1.8. The business involved, the arrangements for the Transfer and the effect of the Transfer are discussed in
more detail in Sections 3 to 11 of this Report.
The Independent Expert
1.9. I, Gary Wells, have been appointed by MSIEu as the Independent Expert to consider the Scheme under
Section 109 of FSMA. My appointment has been approved by the PRA; this is confirmed in a letter dated 26
March 2013 from the Financial Services Authority (“FSA” the predecessor of the PRA and FCA) to MSIEu.
1.10. I am a Fellow of the Institute and Faculty of Actuaries, having qualified in 1986.
1.11. I am a Principal of Milliman LLP, Consultants and Actuaries, (“Milliman”) and I am based in its UK general
insurance practice. My experience of general insurance includes the (reserved) roles as the Signing Actuary
to Lloyd‟s syndicates and Irish non-life (re)insurance companies. A list of previous schemes for which I have
acted as independent expert under the terms of FSMA, and as an independent actuary under the Insurance
Companies Act 1982, the legislation replaced by FSMA, can be found in Appendix 2.
1.12. I confirm that I do not have any personal, financial, or any other interest in MSIEu or MSIG AG. I have not
acted on behalf of or in relation to MSIEu or MSIG AG in any professional capacity.
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1.13. Other consultants within Milliman have undertaken work for companies within MS & AD Insurance Group
Holdings Inc. (“MS & AD”), but revenue for this work has been less than 0.3% of the firm‟s annual global fee
income over each of the last 5 years.
1.14. I do not believe that the involvement of other Milliman consultants with MS & AD affects my ability to act
independently in my assessment of the Scheme.
1.15. This Scheme is subject to sanction by the Court under Section 111 of FSMA.
1.16. MSIG AG will be responsible for payment of all fees in respect of my work as Independent Expert.
The Scope of my Report
1.17. The scope of my work has been reviewed by the FSA (whose functions in relation to insurance business
transfers were assumed by the PRA and the FCA with effect from 1 April 2013) and is set out in Appendix 3.
1.18. I have considered the terms of this Scheme only and have not considered whether any other scheme may
provide a more efficient or effective outcome.
1.19. The Report describes the proposed transfer and the likely effects on policyholders of MSIEu and MSIG AG,
including effects on security and levels of service. These factors are contrasted to the position which will
apply after the completion of the proposed transfer. This Report should be read in conjunction with the full
terms of the proposed Scheme.
1.20. My work has required an assessment of the liabilities of MSIEu and MSIG AG, for the purposes of describing
the effect of the Transfer. My review of the liabilities was based on actuarial reserve assessments conducted
by internal and/or external actuaries of MSIEu or MSIG AG (as the case may be). I have reviewed the
methodology and assumptions used in their work and assessed the key areas of uncertainty in relation to
these liabilities. I have not attempted to review in detail the calculations performed by the internal and/or
external actuaries (as the case may be) or to produce independent estimates of the liabilities.
1.21. In addition to the liabilities, I have assessed the appropriateness, in nature and amount, of the assets to be
transferred under the Scheme, and the capital position of MSIEu and MSIG AG pre and post the proposed
transfer. Again, I have not attempted to review in detail the calculations performed for/by MSIEu or MSIG
AG, or to produce independently my own capital estimates.
1.22. As far as I am aware, there are no matters which I have not taken into account in undertaking my
assessment of the Scheme and in preparing this Report, but which nonetheless should be drawn to the
attention of policyholders in their consideration of the Scheme.
1.23. In reporting on the Scheme as the Independent Expert, I recognise that I owe a duty to the Court to assist
the Court on matters within my expertise. This duty overrides any obligation to the companies involved in the
Scheme. I confirm that I have complied with this duty.
1.24. I am aware of the requirements regarding experts set out in Part 35 of the Civil Procedure Rules, Practice
Direction 35 and the Protocol for Instruction of Experts to give Evidence in Civil Claims.
1.25. I confirm that I have made clear which facts and matters referred to in this Report are within my own
knowledge and which are not. Those that are within my own knowledge I confirm to be true. The opinions I
have expressed represent my true and complete professional opinions on the matters to which they refer.
1.26. Shortly before the date of the Court hearing at which an order sanctioning the Scheme will be sought, I will
prepare a supplementary report covering any relevant matters which might have arisen since the date of this
Report. It is intended that the supplementary report will be published on the MSIEu website at least one
week before the date of that Court hearing.
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The Structure of my Report
1.27. The remainder of the Report is set out as follows:
In Section 2, I provide some background to the regulatory environment in which the companies
involved in the Scheme operate;
In Sections 3 and 4, I provide some background to MSIEu and to MSIG AG, i.e. the companies
involved in the Scheme;
Section 5 summarises the key provisions of the Scheme;
Section 6 describes the matters I need to consider as Independent Expert;
In Section 7, I consider the likely effects of the Scheme on the group of transferring policyholders;
In Section 8, I consider the impact of the Scheme on the policyholders remaining in MSIEu;
In Section 9, I consider the impact of the Scheme on the current policyholders of MSIG AG;
In Section 10, I cover more general issues relating to the Scheme;
My conclusions are summarised in Section 11.
Reliances and Limitations
1.28. In carrying out my review and producing this Report I have relied, without detailed verification, upon the
accuracy and completeness of the data and information provided to me, in both written and oral form, by
MSIEu and MSIG AG. Reliance has been placed upon, but not limited to, the information detailed in
Appendix 4. My opinions depend on the substantial accuracy of this data, information and the underlying
calculations.
1.29. The Report has been prepared for the purposes of the Scheme in accordance with Section 109 of FSMA. A
copy of this Report will be sent to the PRA and the FCA and will accompany the Scheme application to the
Court.
1.30. This Report must be considered in its entirety, since individual sections, if considered in isolation, may be
misconstrued.
1.31. Neither the Report, nor any extract from it, may be published without my specific written consent having
been given, save that copies of the Report may be made available for inspection by policyholders and copies
may be provided to any person requesting the same in accordance with legal requirements. I also consent to
the Report being made available on the website to be operated by MSIEu in connection with the transfer.
1.32. No summary of the Report may be made without my express consent. I will provide a summary of the Report
for inclusion in a document that will be made available to policyholders of MSIEu and MSIG AG under the
Scheme.
1.33. The Report has been prepared within the context of the assessment of the terms of the Scheme and must
not be relied upon for any other purpose. No liability will be accepted by Milliman, or me, for any application
of the Report to a purpose for which it was not intended or for the results of any misunderstanding by any
user of any aspect of the Report. In particular, no liability will be accepted by Milliman or me under the terms
of the Contracts (Rights of Third Parties) Act 1999.
1.34. Actuarial estimates are subject to uncertainty from various sources, including changes in claim reporting
patterns, claim settlement patterns, judicial decisions, legislation, economic and investment conditions. It
should therefore be expected that the actual emergence of claims, premiums, expenses and investment
income will vary from any estimate. Such variations in experience could have a significant effect on the
results and conclusions of this Report. No warranty is given by Milliman or me that the assumptions, results
and conclusions on which this Report is based will be reflected in actual future experience.
1.35. This review does not comprise an audit of the financial resources and liabilities of MSIEu or MSIG AG.
1.36. This Report should not be construed as investment advice.
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1.37. At the date of this Report, I am not aware of any material changes in circumstances since
31 December 2012 other than those referred to in this Report. This Report also takes no account of any
information that I have not received, or of any inaccuracies in the information provided to me.
1.38. The use of Milliman‟s name, trademarks or service marks, or reference to Milliman directly or indirectly in any
media release, public announcement or public disclosure, including in any promotional or marketing
materials, websites or business presentations is not authorised without Milliman‟s prior written consent for
each such use or release, which consent shall be given at Milliman‟s sole discretion.
Legal Opinions
1.39. I have discussed with the senior management of MSIEu and MSIG AG and their legal advisors those areas
where I believe a legal view may be required. For those areas requiring legal input I have in the first instance
sought advice from the legal advisers to MSIEu (in relation to the Scheme). I have reviewed the legal advice
so provided and considered whether it was measured, appropriate and/or contentious/uncertain. In all cases,
I felt the legal advice provided was measured and appropriate.
1.40. Nonetheless, I have retained a firm of German lawyers to provide wholly independent legal advice in relation
to the Scheme, particularly on matters requiring German legal views/opinions,
Professional and Regulatory Guidance
1.41. I am required to comply with relevant professional standards and guidance issued by the Board for Actuarial
Standards and the Institute and Faculty of Actuaries. I have complied with such standards, subject to the
principles of proportionality and practicability.
1.42. The Report has been prepared in accordance with the following Technical Actuarial Standards (“TAS”)
issued by the Board for Actuarial Standards:
Transformations TAS (“T-TAS”);
Insurance TAS (“I-TAS”);
TAS for Data (“TAS-D”); and
TAS for Reporting (“TAS-R”).
1.43. The Report has been prepared under the terms of the guidance set out in Chapter 18 of the Supervision
Manual (“SUP18”) contained in the PRA Handbook of Rules and Guidance to cover scheme reports on the
transfer of insurance business.
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2. REGULATORY BACKGROUND
Introduction
2.1. In this section I describe the UK and German general insurance markets and the regulatory regimes in each
country.
Overview of the UK Insurance Market
BACKGROUND
2.2. According to statistics from the Organisation for Economic Co-operation and Development (OECD) for the
year 2008, the UK general insurance industry consists of 154 domestic undertakings with gross written
premium of approximately £64 billion and gross claim payments of approximately £27 billion. Of all European
countries where data is provided by the OECD, the UK ranked 2 out of 25 countries in terms of gross written
premium.
2.3. UK-based general insurers, as well as other financial services organisations, are regulated by both the PRA
and the FCA using a system of dual regulation. Between them, the PRA and the FCA have more than 4,000
employees and a combined annual budget of over £400 million.
2.4. The PRA and the FCA are statutory bodies set up under the Financial Services Act 2012 (“FinSA”). All
regulatory responsibility was transferred from the FSA to the Bank of England, the PRA and/or the FCA, as
appropriate, effective 1 April 2013. This process was termed „legal cutover‟ (“LCO”).
2.5. The PRA is part of the Bank of England and is responsible for:
Prudential regulation of banks, building societies and credit unions, insurers and certain major
investment firms;
Promoting the safety and soundness of the firms it regulates, seeking to minimise the adverse
effects that they can have on the stability of the UK financial system; and
Contributing to ensuring that insurance policyholders are appropriately protected.
2.6. The FCA is a separate institution and is responsible for:
Ensuring that its relevant markets function well;
Conduct regulation of all financial firms;
Prudential regulation of those financial services firms that are not supervised by the PRA.
2.7. A Memorandum of Understanding (“MoU”) has been established between the PRA and the FCA, which sets
out the high level framework by which the two new regulatory bodies will co-ordinate. In particular, the MoU
requires the PRA and FCA to co-ordinate with each other in advance of insurance business transfers under
Part VII of FSMA.
2.8. The PRA sets the regulations governing the amount and quality of solvency capital held by firms; these are
summarised below. The solvency regime is designed to protect the benefit security of policyholders, as well
as the stability of the insurance industry.
2.9. The FCA is concerned with achieving fair outcomes for consumers and seeks to ensure that firms adhere to
its conduct principles.
2.10. For the purposes of this Report where I refer to the “Regulator” this should be taken to refer to the FCA
and/or the PRA as appropriate.
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TAXATION
2.11. In the UK, the taxation regime taxes general insurance companies based on profits achieved by those
companies at the main rate of corporation tax (23% for tax year 2013/141).
FSCS
2.12. Consumer protection is also provided by the Financial Services Compensation Scheme (“FSCS”). This is a
statutory “fund of last resort” which compensates customers in the event of the insolvency (or other defined
default) of a financial services firm authorised by the Regulator. Insurance protection exists for private
policyholders and small businesses (annual turnover less than £1 million) in the situation when an insurer is
unable to meet its liabilities. For non-life insurance business, the FSCS will pay 100% of any claim incurred
before the wind-up under compulsory insurance (such as motor third party liability) and 90% of the claim
incurred before the wind-up for non-compulsory insurance (such as home insurance), without any maximum.
The FSCS is funded by levies on firms authorised by the Regulator.
2.13. There are no EU wide arrangements to pay compensation to customers of failed insurance entities. The
Regulator, therefore, requires all insurers undertaking business in the UK (whether based in the UK, the
subsidiary or branch of an overseas insurer or under pass-porting arrangements) to join the FSCS.
FOS
2.14. The Financial Ombudsman Service (“FOS”) provides private individuals (and micro enterprises2) with a free,
independent service for resolving disputes with financial companies. It is not necessary for the private
individual (or micro enterprise) to live or be based in the UK for a complaint to be dealt with by the FOS. It is
necessary for the insurance policy concerned to be, or have been, administered from within the UK.
RISK-BASED CAPITAL FRAMEWORK
2.15. At the end of 2004 the FSA introduced a risk-based capital framework (known as the ICAS framework) under
which companies are required to assess solvency under two regimes, referred to as Pillar I and Pillar II. This
framework is now supervised by the PRA.
PILLAR I
2.16. Under Pillar I, general insurers have to meet statutory requirements based on EU Directives and, for the time
being, provide their more risk-based Enhanced Capital Requirement (“ECR”) calculation to the PRA in
private. This includes setting up Technical Provisions in accordance with those Directives and having
sufficient available capital to meet at least the Minimum Capital Requirement (“MCR”). Details of the
calculation of the MCR are given in Appendix 5.
2.17. The Technical Provisions required under the EU Directives are:
The Unearned Premium Reserve (“UPR”) – the UPR is the amount set aside from premiums written
before the valuation date to cover risks incurred after that date;
The Unexpired Risk Reserve (“URR”) – the URR is the amount held in excess of the UPR, to allow
for any expectation that the UPR will prove to be insufficient as at the valuation date to cover the
cost of claims and expenses incurred during the period of unexpired risk; and
The claims outstanding provision – the reserve set up in respect of the liability for all outstanding
claims at the valuation date, whether reported or not.
2.18. The UPR is typically calculated on a daily basis (but alternative methods may be acceptable where the daily
basis is not appropriate) and makes no allowance for the time value of money (i.e. discounting).
1 The UK Corporation Tax rate is expected to reduce to 21% in 2014/15.
2 Micro-enterprises (an EU term covering smaller businesses) can bring complaints to FOS as long as they have an annual turnover of less than €2
million and fewer than ten employees.
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2.19. The claims outstanding provision is typically made-up of the case reserves plus the amount, if any, for claims
incurred but not reported (“IBNR”) at the valuation date. Case reserves are the amounts estimated on a
case-by-case basis to settle reported (open) claims. The IBNR reserve is the amount estimated (typically
using statistical techniques) to provide for claims in respect of claim events that have occurred before the
valuation date, but had still to be reported to the insurer by that date (plus any projected deficiencies in the
case reserves).
2.20. Under UK regulatory practices, the claims outstanding provision estimate cannot normally include any
allowance for the time value of money. Therefore, all other things being equal, a margin exists in the
provision to cover (at least in part) adverse claims development. It should be noted that there are some
limited circumstances under UK regulations where the claims outstanding provision may be discounted for
the time value of money.
PILLAR II
2.21. The capital that must be held under Pillar II is an amount based upon the Individual Capital Assessment
(“ICA”), which is the company‟s own assessment of its capital requirements. Pillar II is intended to provide a
more realistic and complete view (than under the Pillar I regime) of the risks to which the company is
exposed and to provide a framework within which the company should be managed.
2.22. The PRA requires firms, when preparing their ICA, to identify the major risks they face and, where capital is
appropriate to mitigate those risks, to quantify how much (and what type) of capital is appropriate. The PRA
expects firms to conduct stress tests and scenario analyses in respect of each risk. The capital requirements
so determined are then aggregated, allowing for diversification between risks where appropriate. These
stress tests and scenario analyses, together with the supporting analysis, must be documented and, along
with the results, submitted to the PRA (on request) as the ICA. The company is not required to publish its
Pillar II capital requirement.
2.23. The PRA will review the ICA periodically and may prescribe an additional amount of capital that must be held
by the firm in addition to the ICA. The total amount of Pillar II capital prescribed by the PRA is usually
expressed as a percentage of the ECR, and is called Individual Capital Guidance (“ICG”). The ICG is not
published and details of this remain private between the company and the PRA.
2.24. For the ICA, a firm will assess the amount of capital it needs to hold to remain able to meet its liabilities as
they fall due in all but the most extreme circumstances. The PRA has indicated that ICG will be given taking
into consideration capital resources consistent with a 99.5% confidence level that the firm will be able to run-
off its liabilities on the balance sheet and support one year of future trading or, if appropriate to the firm‟s
business, an equivalent lower confidence level over a longer timeframe.
FCA CONDUCT PRINCIPLES
2.25. Within its „Journey to the FCA‟ document, the FCA notes that it expects firms to continue to demonstrate that
they are achieving the six consumer outcomes set out in an FSA document entitled “Treating customers
fairly – towards fair outcomes for consumers” (“TCF”) published in July 2006. The aim of this document was
to develop Principle 6 of the FSA‟s Principles for Businesses (PRIN 2.1.1) which stated that “a firm must pay
due regard to the interests of its customers and treat them fairly”. Principle 7 outlined that “a firm must pay
due regard to the information needs of its clients, and communicate information to them in a way which is
clear, fair and not misleading” while Principle 8 stated that “a firm must manage conflicts of interest fairly,
both between itself and its customers and between a customer and another client”.
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2.26. The six outcomes are as follows:
Outcome 1: Consumers can be confident that they are dealing with firms where the fair treatment of
customers is central to the corporate culture;
Outcome 2: Products and services marketed and sold in the retail market are designed to meet the needs
of identified consumer groups and are targeted accordingly;
Outcome 3: Consumers are provided with clear information and are kept appropriately informed before,
during and after the point of sale;
Outcome 4: Where consumers receive advice, the advice is suitable and takes account of their
circumstances;
Outcome 5: Consumers are provided with products that perform as firms have led them to expect, and the
associated service is of an acceptable standard and as they have been led to expect; and
Outcome 6: Consumers do not face unreasonable post-sale barriers imposed by firms to change product,
switch provider, submit a claim or make a complaint.
THE INSURERS (REORGANISATION AND WINDING UP) REGULATIONS 2004
2.27. Under UK law, the winding-up of an insurance undertaking is governed by the Insurers (Reorganisation and
Winding Up) Regulations 2004. Under these regulations insurance claims have precedence over any claim
on the insurance undertaking with the exception of certain preferential claims (e.g. claims by employees,
rights in rem etc.) with respect to the whole of the insurance undertaking‟s assets. Therefore, direct
policyholders rank equally and above inwards reinsurance policyholders and all other unsecured/non
preferential creditors in the event that an insurer is wound up.
THE FINANCIAL INFORMATION IN THIS REPORT
2.28. The ICAS framework Pillar I balance sheet items as at 31 December 2012 shown in this Report have been
published, externally audited and approved by the Board of MSIEu.
2.29. As stated above, under the ICAS framework, Pillar II financial information is not published and remains
private between the PRA and the company. I have therefore reviewed this information, and commented on it
in general terms, but have not included any Pillar II figures for MSIEu in this Report.
Overview of the German Insurance Market
BACKGROUND
2.30. Germany is the largest economy in Europe and a very important European hub for both insurance and
reinsurance. According to the Statistical Yearbook of German Insurance 2012 from the Gesamtverband der
Deutschen Versicherungswirtschaft e.V. (GDV), the German general insurance industry (including health
insurers) for the year 2011 consisted of 263 private insurance undertakings with gross written premium of
approximately €91 billion and gross claim payments (insurance benefits) of approximately €82 billion.
THE CURRENT REGULATORY REGIME IN GERMANY
2.31. Insurance companies in Germany are licensed and regulated by the Federal Financial Supervisory Authority
(in German, “Bundesanstalt fur Finanzdienstleistungsaufsicht”) better known as “BaFin”. BaFin was formed
on 1 May 2002 under the Financial Services and Integration Act. The aim of this legislation was to create
one integrated financial regulator to supervise all financial markets in Germany. The model was designed to
assist with transparency and manageability, and to ensure that all financial activity was regulated.
2.32. BaFin is an independent federal institution and falls under the supervision of the German Federal Ministry of
Finance. BaFin supervises roughly 600 insurance undertakings, as well as about 2,100 banks and 700
financial services institutions (as of 31 December 2009).
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2.33. German insurance companies are required to hold solvency capital in accordance with the EU Solvency I
Directive. Under these regulations, assets are valued broadly at market value, and reserves are calculated
on a prudent basis. There is no statutory requirement to hold capital similar to the UK‟s (ICAS framework)
Pillar II requirements in Germany.
2.34. Under a detailed scheme issued under binding regulation (in accordance with HGB3 accounting) each
German insurance undertaking has to calculate the Equalisation Provision for each line of business, i.e.
there is no discretion for insurers in the calculation of the Equalisation Provision. Any deviation from the
scheme requires BaFin approval. The calculation of the German Equalisation Provision is largely formula
driven, and in essence increases the provision in profitable years and releases some (or all) of the provision
during unprofitable years, based on current year net figures (as gleaned from the Profit & Loss or “income
statement”).
2.35. In January 2009, in anticipation of Solvency II, BaFin published the "Minimum Requirements for Risk
Management in Insurance Undertakings" (Mindestanforderungen an das Risikomanagement von
Versicherern – "MaRisk (VA)" in circular 3/2009. This circular provides the Supervisory Authority‟s binding
interpretation of §64a of the Insurance Supervision Act (Versicherungsaufsichtsgesetz “VAG”) for German
insurers. VAG has been in-force since January 2008 and lays down the supervisory requirements for
insurers with regard to risk management and the wider system of governance. Risk management, within the
meaning of MaRisk VA, includes the definition of an appropriate risk strategy consistent with the chosen
business strategy, adequate organisational and operational rules, the establishment of an appropriate
internal risk treatment and control system, as well as the establishment of an internal auditing system and
the implementation of internal controls (see Appendix 6 for further details).
PROTEKTOR (PROTECTION SCHEME)
2.36. Consumer protection is also provided by a special protection scheme in place for insurers called
Protektor/Medicator. Protektor and Medicator safeguard Life and Health insurance companies respectively.
There is no comparable scheme for non-life insurance business. This protection scheme is supervised by
BaFin, which provides independent protection of Life and/or Health policyholders and adequate
compensation in the event of insolvency. The scheme is funded by contributions of participating insurers,
which are paid continuously. It follows therefore that there is no equivalent FSCS protection for relevant
Transferring Policyholders.
OFV (OMBUDSMAN)
2.37. The German Ombudsman for Insurers (Ombudsman für Versicherungen e.V., OfV) deals with complaints
from customers (private individuals) of affiliated insurers about their insurances. If the complaint is justified,
the ombudsman can issue a binding decision to resolve the dispute, provided that the award does not
exceed the amount of €10,000. In addition, the OfV is authorized to act as conciliation board for the extra-
judicial settlement of disputes between insurance intermediaries or insurance advisers and policyholders in
connection with the mediation of contracts of insurance (§214(1) No 2 Insurance Contract Act,
Versicherungsvertragsgesetz, VVG).
WINDING-UP LEGISLATION
2.38. Under German law, the winding-up of an insurance undertaking is mainly governed by/codified in §88 et seq.
of the Insurance Supervision Act (Versicherungsaufsichtsgesetz, VAG). In addition §77a VAG stipulates that
insurance claims have absolute precedence over any other claim on the insurance undertaking, with respect
to assets representing the technical provisions.
3 HGB is a law that governs the primary commercial code for companies in Germany. Included in the law is regulation related to the preparation of
financial statements. This law is similar to the generally accepted accounting principles (GAAP), which are followed in the United States.
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TAXATION
2.39. In Germany, corporation tax (including solidarity surcharge) and trade tax are levied on the taxable income
of the insurer as determined for German corporation tax and trade tax purposes. The corporation tax rate
(including solidarity surcharge) amounts to 15.825%. Trade tax is a local tax and - depending upon the so-
called municipality rate - generally ranges between 12% and 14.5%.
THE FINANCIAL INFORMATION IN THIS REPORT
2.40. The Solvency I balance sheet items as at 31 December 2012 shown in this Report have been published,
externally audited and approved by the Board of MSIG AG.
Differences between the UK and Germany
CAPITAL AND RESERVE REQUIREMENTS
2.41. The main difference between the prescribed capital rules in the UK and those in Germany is that German
regulations do not require the calculation of Pillar II capital (under the ICAS framework). The result of this
difference is that the German regime is generally less onerous than the UK Pillar II requirements (under the
ICAS framework).
2.42. The outstanding claim reserve and unearned premium reserve calculation requirements, being based on the
same EU directives, are generally consistent between the UK and Germany. German insurers must hold
Technical Provisions as described in paragraphs 2.17 to 2.19 above and these must not be discounted for
the time value of money. As per the UK, the choice of actuarial methods used by German insurers to
determine reserves is not prescribed, but left to the judgement of the insurer.
2.43. Equalisation Provisions established by German insurers typically use a stronger basis than that mandated in
the UK. The result of this difference is that the UK regime is generally less onerous than the German regime
with regard to the establishment of Equalisation Provisions.
SECURITY UNDER WINDING-UP
2.44. In the event of the winding up of an insurance company under German regulations, insurance claims take
absolute precedence over any other claim on the insurer, with respect to assets representing the Technical
Provisions (subject to certain rules).
2.45. In the event of the winding up of an insurance company under UK regulations, insurance claims take
absolute precedence over any other claim on the insurer, with the exception of certain preferential claims
(including claims on assets subject to rights in rem), with respect to the whole of the insurance company‟s
assets.
2.46. It follows therefore that in the case of a winding-up of an insurance company where there are sufficient
assets to cover the Technical Provisions the German regime in respect of the priority of insurance debts
generally would be expected to be at least as favourable to policyholders and beneficiaries as the UK
regime.
2.47. Conversely, in the situation of a winding-up of an insurance company where there are insufficient assets to
cover the Technical Provisions the UK regime in respect of the priority of insurance debts generally would be
expected to be at least as favourable to policyholders and beneficiaries as the German regime.
2.48. The comparative position of policyholders in a UK insurer versus policyholders in a German insurer in a
winding up situation is therefore a function of the assets available (and their size relative to the Technical
Provisions) and the proportion of inwards reinsurance business relative to direct business.
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Solvency II
2.49. The regulatory solvency reporting requirements for EU insurers and reinsurers are due to undergo a major
overhaul as they will need to meet the requirements of a new solvency regime that are currently being
developed by the European Commission. This new regime is commonly referred to as Solvency II and aims
to introduce solvency requirements that reflect better than the existing solvency regimes the risks that
insurers and reinsurers actually face and to introduce consistency across the European Union. UK and
German companies will be required to adhere to a set of new, risk based capital requirements and, in
contrast to the position under the current UK Pillar II requirements, some of the results will be shared with
the public. The formal date for full implementation of these new rules is expected to be in 2016, although it
may be later.
2.50. Solvency II will be a principles-based regime and will be based on three pillars:
Under Pillar I quantitative requirements define a market consistent4 framework for valuing the
company‟s assets and liabilities;
Under Pillar II, insurers must meet minimum standards for their corporate governance, and also for
their risk and capital management. There is a requirement for permanent internal audit and
actuarial functions. Insurers must regularly complete an Own Risk and Solvency Assessment ;
Under Pillar III, there are explicit requirements governing disclosures to supervisors and
policyholders.
2.51. The Solvency Capital Requirement (“SCR”) in Solvency II is the amount of capital required to ensure
continued solvency over a 1 year time frame with a probability of 99.5%. The SCR is calculated based on the
particular risks to which the insurer is exposed.
2.52. The Minimum Capital Requirement under Solvency II (“MCR2”), which will be lower than the SCR, defines
the point of intensive regulatory intervention. The MCR2 calculation is more formulaic and less risk sensitive
than the SCR calculation.
2.53. The basis for the Solvency II calculations has not yet been finalised, although some indicative calculations
have been prepared by MSIEu and MSIG AG to assess the likely impact of the new regime. I have
discussed the likely impact of the Scheme on a Solvency II basis separately with the senior management of
MSIEu and MSIG AG. Through these discussions, consideration has been given to the potential change in
financial strength under Solvency II as a result of the Scheme.
4 A market-consistent framework requires the values placed on assets and liabilities to be consistent with the market prices of listed securities and
traded derivative instruments.
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3. BACKGROUND ON MSIEU
Introduction
3.1. MSIEu is a UK insurance company registered in England and Wales (registered number: 01063340). It is
authorised and regulated by the PRA and the FCA with permission under Part 4A of FSMA to carry out
contracts of general insurance falling within classes 1-18 inclusive of Part I of Schedule I of Financial
Services and Markets Act 2000 (Regulated Activities) Order 2001 (“the RAO”), excluding classes 3 and 10.
3.2. MSIEu was established in 1972 as an indirect subsidiary of Mitsui Sumitomo Insurance Company Ltd
(“MSIJ”) (see paragraph 3.7 below for further details). Prior to this, MS & AD had operated a representative
office of MSIJ in London since 1924. MSIEu‟s core business arises predominantly from direct insurance of
Japanese companies within Europe and the rest of the world. This business is also termed Japanese
Interests Abroad (“JIA”) and is distinguished from non-JIA business.
3.3. There are four main parts to MSIEu‟s insurance business: JIA, non-JIA, pool participations and run-off. JIA
and non-JIA policies are typically written into distinct JIA and non-JIA branches of MSIEu.
3.4. MSIEu‟s main classes of insurance business are property, liability, engineering, accident, marine and
aviation. Policies can be written on both a packaged and on a stand-alone basis. Both JIA and non-JIA
business may be written into these classes although JIA and non-JIA policies are identified and managed
separately. MSIEu‟s main pool participation is via Global Aerospace Underwriting Managers (“GAUM”), a
London Market aviation pool.
3.5. From 2007 MSIEu strategically grew its non-JIA business and established various insurance branches (or
„desks‟) outside the UK in order to source non-JIA business. These branches included Germany (2007),
France (2009), Qatar (2009) and Slovakia (2009). The German branch is the largest in terms of annual
premium income and has grown substantially since 2007. The Qatar branch is being closed to new
(including renewed) business with effect from 1 July 2013.
3.6. MSIEu‟s insurance operations have been backed by a Credit Guarantee Agreement with MSIJ since 2007.
Under the terms of this agreement, MSIJ undertakes to pay valid claims should MSIEu be unable to meet
such liabilities as they fall due (see paragraph 3.27 below for further details). MSIJ is additionally an
important provider of outwards reinsurance protection to MSIEu.
3.7. MSIEu is a wholly owned subsidiary of MSIG Holdings (Europe) Ltd (“MSIGHE”), which is in turn a wholly
owned subsidiary of MSIJ. MSIJ is in turn a wholly owned subsidiary of MS & AD, which is registered and
regulated in Japan.
3.8. As at 31 December 2012, the most recent date for which full financial information on MSIEu is available, the
called up share capital of MSIEu was £160,900,000 (2011: £160,900,000; 2010: £66,900,000) of issued and
fully paid irredeemable ordinary shares of £1 each.
3.9. During 2011, 94,000,000 ordinary shares of £1 were issued and fully paid at par value. The shares were
issued in two tranches of 14,000,000 on 4 May 2011 and 80,000,000 on 10 August 2011 (as part of
Remediation Programme – see paragraphs 3.28 to 3.31 below).
3.10. As at 31 December 2012, MSIEu‟s total Admissible Assets amounted to £485.1 million, Technical Provisions
amounted to £287.2 million (gross of reinsurance), and other liabilities amounted to £76.6 million, thereby
producing regulatory (Solvency I) capital resources of £121.3 million.
Overview of Business Written
3.11. The majority of MSIEu‟s insurance business is sourced from international or domestic brokers, although a
small proportion of the business is written on a direct basis (predominantly JIA household business). MSIEu
has a number of fronting partners who cede business to MSIEu, normally on a facultative basis. The main
purpose of these fronting arrangements is to provide MSIEu‟s clients with a co-ordinated service across
territories, including those in which MSIEu does not currently have a licence to underwrite.
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3.12. MSIEu‟s target market for JIA business is commercial business and industrial business. In addition, while not
a target market, MSIEu underwrites personal household business in a bid to cement and further its
relationships with its large corporate clients, supporting their expatriate employees as required. The main
lines of JIA business are:
Property – covering damage to property and business interruption type risks (including some
engineering risks). The main types of exposures include buildings/plants for pharmaceuticals, oil
and chemical refilling, processing of plastics, textiles, electrical and electronic products, land motor
(i.e. buildings/plants for Japanese motor companies) and food processing. There is also some
household business affiliated to corporate clients, primarily in the UK and Germany;
Cargo – covering cargo risks for electronics and associated business, vehicles, and other business;
Liability – covering general liability (and UK Employers liability) risks;
Personal Accident (PA) – covering general and travel PA risks (there are a small number of
individual policies);
Miscellaneous – a small mixed book of business, including glass insurance, theft insurance and
EDP (computer) insurance.
3.13. MSIEu‟s target market for non-JIA business is industrial business in Germany and France, mid-corporate to
large industrial business in Slovakia and commercial and industrial business in Qatar5 (all of which is inwards
reinsurance business). The main lines of non-JIA business are:
Property – covering damage to property and business interruption type risks. The main types of
exposures include buildings/plants for communications and media, hotels, hospitals,
pharmaceuticals, research labs, oil and chemical refilling, electrical and electronic products, land
motor (i.e. buildings/plants for non-Japanese motor companies) and food processing;
Cargo – covering general cargo, hull, building, freight, forwarding, cash-in-transit and agency risks
(mostly written through the German branch);
Liability – covering in the main general risks, e.g. premises, public, product and environmental
exposures, largely associated with the chemical and pharmaceutical industries. A significant
number of risks are written on a coinsurance basis where MSIEu is typically a following co-insurer;
Engineering – covering erection all risks, machinery (including business interruption) risks,
contractors all risks, guarantee risks and electronics risks.
3.14. MSIEu‟s insurance portfolio also includes various types of business that has been discontinued (“run-off”
business). The run-off portfolio includes US related asbestos, environmental pollution and health hazard
(„US APH‟) exposure and some London Market excess of loss spiral business, arising through MSIEu‟s
legacy participation in the Willis Faber Underwriting Manager (“WFUM”) pool, and the old Sumitomo
business. In addition, there is one other run-off account: the Belgian marine pool (“BDM”), which relates to a
small amount of cargo business.
Reinsurance
3.15. MSIEu fronts a large number of insurance policies to MSIJ (i.e. these policies are 100% reinsured with
MSIJ). Approximately one quarter of the JIA business written by MSIEu is fronted to MSIJ.
3.16. MSIEu also cedes 100% of the GAUM business it writes to MSIJ (i.e. MSIEu essentially fronts the aviation
pool business for MSIJ).
5 It should be noted that the Qatar branch of MSIEu is to be closed to new and renewed business during 2013.
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3.17. MSIEu and MSIG AG are reinsured jointly under the same reinsurance programme. For non-fronted JIA
business, the companies have, in broad terms, the following reinsurance protections;
Property – quota share, surplus and excess-of-loss arrangements sitting on top of a net retention
of £3m/€4.5m covering losses up to £132.5m/€198.75m;
Cargo – excess-of-loss arrangements sitting on top of a net retention of £2m/€3m covering losses
up to £30m/€45m;
Liability – excess-of-loss arrangements sitting on top of a net retention of £1.667m/€2.5m covering
losses up to £10m/€15m. In addition, there is a clash cover sitting on top of a net retention of
£1.667m/€2.5m covering losses up to £6.667m/€10m;
PA – excess-of-loss arrangements sitting on top of a net retention of £0.5m/€0.75m covering
losses up to £10m/€15m.
3.18. For non-JIA business, the companies have broadly the following reinsurance protections;
Property – surplus arrangements sitting on top of a net retention of €4m covering losses up to
€135.25m;
Cargo – excess-of-loss arrangements sitting on top of a net retention of £2m/€3m covering losses
up to £30m/€45m;
Liability – excess-of-loss arrangements with a net retention of €2.5m on the primary layer, a net
retention of 12.5% (€2.5m) on the €20m xs €5m layer and then cover for losses up to €80m. In
addition, there is a clash cover of €10m xs €5m;
Engineering – surplus arrangements sitting on top of a net retention of €2.25m covering losses up
to €42m.
3.19. Following on from the Remediation Programme (see paragraphs 3.28 to 3.31 below) and with effect from 1
October 2011, MSIEu entered into a 100% reinsurance arrangement with MSIJ covering all non-JIA
exposures (i.e. the non-JIA business of the German, French and Slovakian branches of MSIEu, all of which
will transfer under the proposed Scheme, and the MSIEu Qatar branch business that will not transfer under
the proposed Scheme) as follows:
For exposures earned before 1 October 2011, there is a stop loss arrangement, where the
attachment point is determined based on the estimated ultimate claims (net of all inuring intra-
group/external reinsurance) as booked in the management accounts as at 30 September 2011;
For exposures earned after 1 October 2011, all exposures (net of all inuring intra-group/external
reinsurance) are 100% ceded to MSIJ;
This arrangement is structured to run until the last claim (arising from the related exposures) is
settled unless terminated as per the contractual arrangements;
This arrangement, with MSIJ, is one of the treaty reinsurances to be endorsed alongside the
Scheme (as described in paragraph 10.17 below). It, like all other reinsurance arrangements
between MSIEu and MSIJ, is supported by a collateralisation arrangement comprising a Letter of
Credit (“LOC”) issued by the Tokyo Mitsubishi Bank in favour of MSIEu for the amount of £80
million in the event of MSIJ becoming insolvent.
3.20. In addition to MSIJ, MSIEu has a number of external reinsurers providing in whole or part the reinsurance
protections described above.
Risks
3.21. MSIEu is exposed to a large number of risks in the course of its operations. The key risks may be classified
under the headings of insurance, market, liquidity, credit and operational risk.
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3.22. Insurance risk relates to the inherent uncertainties in the occurrence, amount and timing of insurance
liabilities. The principal insurance risk is the risk of reserves set by the company proving to be inadequate.
MSIEu‟s reserves are reviewed regularly by both internal and external actuaries, most recently as at 31
December 2012.
3.23. Market risk relates to MSIEu‟s investment portfolios, and arises mainly from exposure to changes in interest
rates, foreign exchange rates and changes in the market value of property and other assets. A decrease in
the value of the assets backing the insurance contracts could adversely affect the financial position of MSIEu
to the extent that a movement (in particular, a fall) in asset values is not matched by a corresponding
movement in liability values. MSIEu manages interest rate risk through the Investment Committee, which is a
joint committee of MSIEu and Mitsui Sumitomo Insurance (London Management) Limited (“MSILM”). It also
seeks to match liabilities to assets of the same currency. The most significant foreign currencies to which
MSIEu is exposed are Euros and US dollars.
3.24. Liquidity risk relates to the inability of MSIEu to meet its cash outflows as they fall due as a result of a
mismatch in the timing of cash inflows and outflows. The cash position of MSIEu is monitored on a regular
basis to ensure that sufficient funds are available to meet liabilities as they fall due. Funds required to meet
immediate and short term needs are invested in short term deposits. Funds in excess of short term needs
are managed by external fund managers whose performance is closely monitored throughout the year.
3.25. Credit risk relates to the risk of default by counterparties such as reinsurers and on corporate and
government bonds. The directors of MSIEu monitor by business line the company‟s exposure to single, and
groups of connected counterparties. Investment guidelines have also been established that restrict the
amount of the investment portfolio that can be placed with a single issuer, and the level of investment in a
non-sovereign issuer.
3.26. Operational risks are the risks to which MSIEu is exposed during its day to day operations, mainly arising
from possible failures of internal processes, people, systems, regulatory (the risk of failing to comply with
applicable PRA and FCA rules) and legal or from external events. I comment separately on the Remediation
Programme that was established by the directors of MSIEu following governance concerns in 2011.
MSIJ Credit Support Guarantee
3.27. MSIEu has entered into a credit support agreement (“CSG”) with MSIJ. Under the terms of this agreement,
MSIJ undertakes to pay valid claims should MSIEu be unable to meet such liabilities as they fall due. The
agreement can be cancelled by MSIJ (by giving at least 90 days written notice to MSIEu) and shall
thereupon be of no further force or effect in respect of any policies issued or renewed on or after the date of
termination. However, the guarantee in respect of any policies issued or renewed prior to the date of
termination is a continuing guarantee and extends to all sums payable by MSIEu under such policies.
Remediation Programme
3.28. In June 2011 the FSA issued MSIEu with a formal Risk Mitigation Programme („RMP‟). This resulted from
very significant concerns raised by the FSA in respect of MSIEu‟s corporate governance and control. These
concerns culminated in the FSA issuing MSIEu with a Final Notice on 8 May 2012 of a financial penalty of
£3,345,000 as well as a ban on MSIEu‟s then managing director.
3.29. Following the issuance of the RMP, MSIEu engaged independent external advisors to assist with a review of
business processes and corporate governance (the “Remediation Programme” or “RP”). The RP was
conducted in two phases between October 2011 and September 2012, and resulted in 202 areas highlighted
for action by the external advisors. There were further reviews conducted by MSIEu as part of the RP, which
resulted in 400 points to be addressed by the business.
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3.30. I understand that all issues identified within the RP for action were to be implemented by 31 March 2013.
The key outcomes from the RP included:
Revised Board structure and operation, supported by independent non-executive directors;
Restructured governance and committee structure (the main committees being: Executive;
Underwriting & Claims; Finance; Reserving; Risk & Capital; Reinsurance; Audit; and Remuneration &
Nomination);
Revised branch oversight in terms of ownership, responsibility and participation;
Revised risk management structure built on the “three lines of defence” model.
3.31. I have discussed the outcomes of the RP with MSIEu‟s senior management and, at the date of this Report, I
understand that all RP actions have been implemented within the business. The outcome from the RP is a
significant change to the way that MSIEu‟s business is controlled and managed. While rapid change in
business processes inevitably brings its own risks, I believe there is evidence of significant positive
outcomes from the RP (e.g. improved branch oversight) and the scrutiny that has accompanied it, including
scrutiny from independent external parties. These positive outcomes from the RP have substantially
improved MSIEu‟s corporate governance and control.
Fair Treatment of Customers (“TCF”)
3.32. MSIEu is committed to embed the fair treatment of customers, and to ensure that fair outcomes are
delivered to customers, throughout all areas of MSIEu‟s business. The key components of this approach are
set out below:
Senior management are fully briefed and kept informed about TCF performance and issues;
Procedures are in place for promotional material to be reviewed and signed-off prior to release;
Sales staff are trained on all products they advise on or sell and understand who they are and are
not suitable for;
Sales remuneration systems are operated that assure fairness to the customer, rather than only
rewarding sales volumes;
Accurate records are maintained of customer instructions and of the advice and options given
before, during and after sale;
Customer feedback is encouraged and used, where appropriate, to correct or improve on the
service already being offered;
A robust and fair complaints process is in place to ensure that complaints are assessed fairly,
promptly and impartially, and in line with FCA deadlines and rules;
Staff are encouraged to recommend improvements to service and identify areas of both strength
and weakness in order to constantly improve and evolve customer service;
Staff are kept up-to-date with relevant training in relation to TCF, technical competence, data
protection and other matters directly affecting the quality of service offered to customers;
There is regular monitoring and reporting on all TCF activities as part of the monthly management
information by business area (branch), in order to assess TCF performance across the business
areas and recommend changes as appropriate;
The TCF policy is understood and supported by staff.
3.33. The Board of MSIEu has overall responsibility for ensuring that the “fair treatment of customers” objective is
met. It receives periodic reports measuring specific areas that are used to indicate the level of performance
(by relevant business area) with regard to TCF outcomes. Where necessary remedial action is taken.
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4. BACKGROUND ON MSIG AG
Introduction
4.1. MSIG AG is a German insurance company registered in April 2012 with the commercial register of the Local
Court of Cologne (Amtsgericht) under number HRB75277. It was authorised to write general insurance
business (92/49/EEC – classes of insurance 1, 4-9, 10b, 10c, 11-16) from July 2012 and was capitalised at
that time with registered share capital of €84.0m, divided into 84,000,000 registered non-par value shares
(Stückaktien). As well as its head office in Germany, MSIG AG has established branch offices in France and
Slovakia. MSIG AG is a wholly owned subsidiary of MSIJ.
4.2. As at 31 December 2012, MSIG AG had written gross premium of approximately €4m, most of which arose
within the property and liability classes of business. MSIG AG‟s business plan for 2013 shows anticipated
gross written premium of €55.5m.
4.3. It is planned that MSIG AG will take operational responsibility for the continental European business
currently written by MSIEu on a novation basis. MSIG AG will therefore write a similar profile of business in
terms of business type and its mixture of JIA and non-JIA business, although the proportion of non-JIA
business is expected to grow in future years.
4.4. In July 2012, MSIG AG was awarded an „A+‟ financial strength rating by Standard & Poor‟s. This rating was
assigned on the basis of a financial guarantee provided by MSIJ, which also has a financial strength rating
„A+‟ awarded by Standard & Poor‟s. The rating was also affirmed at the end of May 2013.
ORGANISATIONAL STRUCTURE
4.5. Under German law, the organisational structure of a German stock corporation, such as MSIG AG, is such
that the company must have a Management Board and a Supervisory Board. The two bodies have to be
strictly separate, and it is not permissible for any one person to serve on both boards.
4.6. MSIG AG is run by the Management Board, which in turn is supervised by the Supervisory Board. The
Management Board is responsible for the operational management of MSIG AG as well as for its
representations to third parties. The Management Board has collective responsibility for the management of
the company, and while it may install committees or working groups it is not obliged to do so.
4.7. In accordance with the Management Board‟s Terms of Reference, it must report at least the following items
to the Supervisory Board:
Monthly: business, financial and operations reports
Quarterly: risk report
Half-yearly: operations management check, large claims report
Annual: annual review of business strategy and risk strategy, the next year‟s annual plan, investment
policy (including strategic investment policy), compensation arrangements
Various other reports relating to more infrequent events (such as amendments to compliance manual).
4.8. The Supervisory Board supervises the Management Board making use of the reports provided by the
Management Board as described in paragraph 4.7 above. In addition, the Supervisory Board appoints and
dismisses the Management Board, represents the company in disputes between the shareholders and
members of the Management Board, and has to examine and approve the balance sheet, profit and loss
accounts, the annual report and the annual application of profits. Like the Management Board, the
Supervisory Board may install committees or working groups but is not obliged to do so.
4.9. As outlined in paragraph 2.35 above, MaRisk VA is the risk management system required by BaFin and
guidance indicates at least an annual review. Among other matters, it requires insurance companies to
manage the relationship between the business strategy, risk strategy and capital management on a higher
level.
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OUTSOURCED FUNCTIONS
4.10. MSIG AG has partially outsourced a number of its operational functions. I have received copies of the
outsourcing agreements, which were also provided to BaFin as part of the authorisation process.
4.11. The following operations are partially outsourced to MSIG German Services GmbH (“MSIG GS”), a company
based in Dusseldorf, Germany and registered with the commercial register of the Local Court Dusseldorf
under HRB 23329:
Underwriting for all lines of JIA business;
Claim handling for all lines of JIA business. In this context, claim handling includes claim adjustment,
assessment and settlement but excludes IBNR reserve estimation;
Accounting support including balance sheet and profit & loss calculation, managing bank accounts
and account relationships with insurance brokers, reinsurers etc.
IT services.
4.12. MSIG GS was a subsidiary of MSIEu until 5 March 2013 when 100% of the share ownership was transferred
to MSIG AG. MSIG GS‟s outsourcing agreement with MSIG AG was entered into in July 2012.
4.13. In addition, MSIG AG has appointed specific individuals on a contract basis to lead certain key functions in
particular internal audit. MSIG AG is in the process of hiring permanent employees to ensure the MSIG AG
is able to perform the actuarial and internal audit functions in-house (see paragraph 7.155 for further details).
Overview of Business Written
4.14. MSIG AG‟s main classes of insurance business are very similar to those of MSIEu with respect to the
continental European branches, i.e. property, liability, engineering, accident and marine. Policies can be
written on both a packaged and on a stand-alone basis. Both JIA and non-JIA business may be written into
these classes although JIA and non-JIA policies are identified and managed separately.
4.15. MSIG AG currently focuses on industrial business, particularly the property lines and liability lines. It is
planned that MSIG AG will further extend the industrial business in continental Europe in the coming years.
Reinsurance
4.16. The reinsurance programme consists of proportional and non-proportional cover and is adjusted yearly to
reflect the risk-bearing capacity of the company.
4.17. MSIEu and MSIG AG are reinsured jointly under the same reinsurance programme as described in
paragraphs 3.17 and 3.18 above.
4.18. MSIEu is seeking the consent of reinsurers (in respect of the Transferring Business) to adding MSIG AG by
way of an endorsement to various treaty reinsurances. I discuss the reinsurance assets in Section 10 of the
Report.
Risks
4.19. The risks faced by MSIG AG are essentially the same as those presently faced by MSIEu (as outlined in
Section 3). In addition, while the planned takeover of the continental European branches from MSIEu
provides the substance for the further development of the company, it does at the same time represent a
significant operational challenge with associated risks.
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MSIJ Credit Support Guarantee
4.20. MSIG AG has entered into a credit support agreement with MSIJ. Under the terms of this agreement, MSIJ
undertakes to pay valid claims should MSIG AG be unable to meet such liabilities as they fall due. The
agreement has identical terms to the credit support agreement between MSIEu and MSIJ. The agreement
runs indefinitely unless terminated under the terms of the contract.
Fair Treatment of Customers (“TCF”)
4.21. As a general principle of German Insurance Supervisory Law, MSIG AG (like all German insurers) has to
make sure that the interests of their policyholders are preserved and that the laws with regard to the conduct
of insurance business are obeyed (§81 of VAG). Furthermore, BaFin supervises whether MSIG AG acts in
line with this provision.
Policyholder Complaints
4.22. Following the sanctioning of the proposed Scheme, the policyholders of MSIEu currently able to make
complaints to FOS will continue to be able to make complaints to FOS in respect of MSIEu's acts or
omissions as, under the Scheme, MSIG AG will accept liability for any subsequent claims. As a German
insurer, MSIG AG is not under the “compulsory jurisdiction” of the FOS, however, MSIG AG intends to sign
up to the “voluntary jurisdiction” of FOS, meaning that it will agree to deal with complaints – and comply with
the decisions of the FOS – in the same way as under the FOS‟s compulsory jurisdiction.
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5. THE PROPOSED SCHEME
Motivation for the Scheme
5.1. I understand that MS & AD as a global insurer is committed to a long term strategy of profitable expansion in
diverse geographical areas. As part of this strategy, MS & AD has reviewed the structure of its European
operations and decided, as mentioned in paragraph 4.3 above, to form a subsidiary company in continental
Europe (MSIG AG) to complement its existing UK-based companies: MSIEu and MSILM. MS & AD believes
that the creation of MSIG AG will ensure that key decision makers are aligned more closely to both its
existing and target customer base in continental Europe, thereby ensuring it has an optimal business
platform across Europe. It is intended that most of MSIEu‟s legacy continental European insurance policies
will renew into MSIG AG on a novation basis. The Scheme will enable prior year and current year 2013
policyholders within continental Europe to be serviced by one company, MSIG AG.
5.2. Accordingly, the Scheme has been formulated to transfer the relevant continental European insurance
business of MSIEu to MSIG AG. To accomplish this transfer the Court‟s consent is needed.
Outline
5.3. Under the proposed Scheme the continental European insurance business of MSIEu will be transferred to
MSIG AG. All general insurance liabilities in respect of the transferred business, and appropriate assets
(including outwards reinsurance), will be transferred on the Effective Date.
5.4. A schematic showing the transferring business (and corresponding gross written premiums) of MSIEu to
MSIG AG under the proposed Scheme is shown in Figure 5.1 below.
Figure 5.1
Transferring Business under the Scheme
Before Transfer After Transfer
UK JIA
Business
(£28m)
(GAUM)
(£15m)
Continental JIA
branch business
(£38m)
Continental local
branch business
(£82m)
MSIG AG **
Following
Proposed
Part VII
Transfer
MSIEu (end 2012)
UK JIA
Business
(£27m)
(GAUM)
(£17m)
MSIEu *
Qatar
(£4m)
Qatar
(£4m)
*/** Based on 2013 business plan
Continental JIA
branch business
(€45m)
Continental local
branch business
(€113m)
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5.5. A schematic of the (simplified) corporate structure before and after the proposed Scheme is shown in Figure
5.2 below.
Figure 5.2
Simplified Corporate Structure Pre and Post the Scheme
5.6. All future income and outgoings arising from the Transferred Business will pertain to MSIG AG.
5.7. The liability for the Transferring Policies issued by MSIEu, which currently rests with MSIEu, will be
transferred to MSIG AG. Existing policyholders of MSIEu in respect of the Transferred Business will become
policyholders of MSIG AG.
5.8. The Scheme includes a provision that is designed to effect the transfer of applicable reinsurance protections,
from MSIEu to MSIG AG.
5.9. Table 5.1 below shows the simplified balance sheets for MSIEu and MSIG AG as at 31 December 2012 (i.e.
pre-Scheme) based on their respective financial statements, and provides an illustration of the balance
sheets for MSIEu and MSIG AG post-Scheme. It is based on the assumption that the transfer takes place as
at 31 December 2012 (using an exchange rate of £1.00 = €1.23) and that the assets and liabilities
transferred reference the Technical Provisions established by MSIEu as at 31 December 2012 (i.e. there is
no material change in the valuation basis between MSIEu and MSIG AG).
5.10. Further details of the assets that are within MSIEu and MSIG AG pre and post the proposed Transfer are
given from paragraph 10.33 below.
MITSUI SUMITOMO INSURANCE COMPANY LIMITED (“MSIJ)
MSIG HOLDING (EUROPE) LIMITED
MITSUI SUMITOMO INSURANCE COMPANY (EUROPE) LIMITED (“MSIEu”)
GERMAN BRANCH
UK BUSINESS
FRENCH RANCH
QATAR BRANCH
ITALIAN BRANCH
GAUM Pool Participation
NETHERLANDS BRANCH
BELGIAN BRANCH
SLOVAKIAN BRANCH
SPANISH BRANCH
MSIG INSURANCE EUROPE AG (“MSIG AG”)
GERMAN SERVICE COMPANY (“MSIG-GS”)
NORWEGIAN COMPANY (“SMA MSI”)
Part VII
Transfer
MITSUI SUMITOMO INSURANCE COMPANY LIMITED (“MSIJ)
MSIG HOLDING (EUROPE) LIMITED
MITSUI SUMITOMO INSURANCE COMPANY (EUROPE) LIMITED (“MSIEu”)
GAUM Pool Participation
QATAR BRANCH
UK BUSINESS
MSIG INSURANCE EUROPE AG (“MSIG AG”)
NORWEGIAN COMPANY (“SMA MSI”)
GERMAN SERVICE COMPANY (“MSIG-GS”)
BELGIAN BRANCH
GERMAN BUSINESS
NETHERLANDS BRANCH
FRENCH BRANCH
SLOVAKIAN BRANCH
ITALIAN BRANCH
SPANISH BRANCH
Current structure pre transfer: Planned structure post transfer:
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Table 5.1: Simplified Balance Sheets for MSIEu and MSIG AG6 pre and post the Scheme as at
31 December 2012 (£000s)
5.11. As part of the Scheme, MSIG AG is in the process of establishing branches in Belgium, the Netherlands,
Spain and Italy (to receive the corresponding branch businesses from MSIEu). The company has already
established branches in France and Slovakia (to receive the corresponding branch businesses from MSIEu).
The branches in the process of being established are also subject to approval by BaFin, and are expected to
be authorised ahead of the Effective Date of the Scheme.
5.12. No compensation will be paid to the policyholders (or to the shareholder) of MSIEu in consideration of the
transfer of the insurance business (and appropriate assets) of MSIEu to MSIG AG, although MSIG AG will
assume the insurance liabilities in respect of the Transferred Business.
5.13. The external costs of the Transfer will be borne by MSIG AG.
5.14. Nothing in this Report should be regarded as providing a legal opinion on the effectiveness of the proposed
transfer.
5.15. I have not considered any alternative scheme.
Policyholders Affected
5.16. I have considered the effects of the Scheme on three main groups of policyholders, namely:
1. the policyholders of MSIEu whose policies are to be transferred;
2. those policyholders remaining in MSIEu; and
3. the current policyholders of MSIG AG.
5.17. The Effective Date of the Scheme is expected to be 31 December 2013.
Compensation and Complaints
5.18. As a German insurer, MSIG AG will not participate in the FSCS (other than for relevant business written in
the UK). The impact on the Transferring Policyholders of a loss of FSCS protection post-transfer is described
in paragraph 7.118 below.
6 The Equalisation Provision for MSIG AG as at 31 December 2012 is zero. At the Effective Date an Equalisation Provision of circa €30m will need to
be established under German regulatory requirements in respect of the transferred business under the Scheme. MSIG AG will receive additional funds of €30m on or before the Effective Date (see paragraph 7.50 below for further details). Further, the debtors include treaty reinsurance recoveries that are held centrally by MSIEu.
£000sMSIEu (pre
transfer)
MSIEu (post
transfer)
MSIG AG
(pre transfer)
MSIG AG
(post transfer)
Assets
Investments 106,088 60,440 63,461 109,109
Reinsurers' Share of Technical Provisions 211,282 97,436 1,807 115,653
Debtors 81,414 37,301 3,355 47,468
Cash at bank and in hand 79,457 68,741 3,292 38,398
Other Assets 10,067 7,400 906 3,573
488,308 271,318 72,821 314,201
Liabilities
Capital & Reserves 124,545 124,545 65,878 65,878
Technical Provisions (gross) 285,117 130,327 3,157 157,947
Equalisation Provision 2,102 2,102 0 24,390
Creditors 66,135 9,473 1,833 58,495
Other Liabilities 10,409 4,871 1,954 7,492
488,308 271,318 72,821 314,201
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5.19. The transferring policyholders of MSIEu will have recourse to the UK Financial Ombudsman Service as
MSIG AG intends to sign up to the “voluntary jurisdiction” of FOS (see paragraph 4.22 above). In addition,
they also have recourse to the OfV, as described in Section 2.
FCA Conduct Principles
5.20. As noted in Section 2 the FCA place great emphasis on firms achieving fair outcomes for consumers. The
approach of MSIEu to achieving fair outcomes to customers in compliance with the FCA‟s conduct principles
is set out above from paragraph 3.32.
5.21. While MSIG AG is not regulated by the PRA/FCA, it does have to make sure that the interests of its
policyholders are preserved and that the laws with regard to the conduct of insurance business are obeyed
(see paragraph 4.21 above). I have looked at the six outcomes that the FCA expects firms to achieve as part
of TCF (see paragraph 2.26 above) and applied my understanding of TCF to MSIG AG in order to assess
how the company is achieving fair outcomes to customers (see paragraph 7.172 below).
Administration
5.22. If the Scheme is sanctioned, the administration and management of the business remaining in MSIEu will
continue to be carried out by MSIEu, while the business transferring to MSIG AG will be managed and
administered by MSIG AG. The administration and management of the current MSIG AG business will
continue to be carried out by MSIG AG post the proposed Scheme.
5.23. In accordance with the BTA, the employees of MSIEu that support the insurance business conducted
through the German branch (and the Slovakian branch) either transferred to MSIG AG on 1 December 2012,
or will transfer to MSIG AG at a date (on or before the Effective Date) agreed between the respective Boards
of MSIEu and MSIG AG. I am informed that at the date of this Report the majority of German employees
have already transferred.
5.24. Where branch staff have already transferred to MSIG AG, a service agreement (dated 10 January 2012)
exists between MSIG AG and MSIEu whereby MSIEu appoints MSIG AG to provide certain insurance
services to MSIEu through to the Effective Date in relation to the existing (transferring) continental European
branch business. The services in question include: the collection of premiums; settlement of claims; mid-
term adjustments and other administrative functions; liaison and communication with insurance
brokers/intermediaries, insureds and/or other related parties (subject to MSIG AG not being able to bind
MSIEu without the prior approval of MSIEu); and receipt of documents directly from insurance
brokers/intermediaries, insureds and/or other related parties, in each case for and on behalf of MSIEu. This
agreement and its operation are designed to safeguard the servicing of MSIEu‟s existing business.
5.25. I am informed by the Chief Executive Officer of MSIEu (“CEO”) that the agreement has operated
satisfactorily between the two companies and that MSIEu has been able to continue providing a high level of
service to intermediaries and clients throughout the year. I am further informed that the effectiveness of the
service agreement has been monitored in the branch monthly meetings and the CEO is satisfied that there
has been no significant deterioration in any of the key performance indicators.
5.26. In accordance with the BTA (and as a result of the Scheme) the employees in the branches of MSIEu in
Belgium, France, the Netherlands, Spain and Italy will transfer to the branches in the relevant jurisdiction on
the Effective Date. The employees in the Slovakian branch of MSIEu have transferred to the Slovakian
branch of MSIG AG.
Excluded Policies
5.27. Any policies which are not capable of being transferred for legal reasons will be treated as Excluded Policies
and will be fully reinsured to MSIG AG with effect from the Effective Date.
The Capital Policy after the Scheme
5.28. Currently, capital in MSIEu is maintained in accordance with the risk-based approach ICAS regime, as set
out in Section 2, whereas MSIG AG will, as a minimum, need to abide by Germany‟s generally less onerous
Solvency I regime until the implementation of Solvency II.
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5.29. Nonetheless, MSIG AG intends to operate a risk-based capital adequacy test until such time that Solvency II
is implemented, after which it will abide by the new regime (as per the Court Order to the Scheme as set out
in paragraph 7.97 below).
The Approach to Communication with Policyholders
5.30. MSIEu and MSIG AG have set out the approach they intend to take in communicating information about the
proposed transfer of business to the affected policyholders and other parties.
5.31. The main objectives of the communications are to:
Give policyholders the information they need to understand the proposed changes;
Inform affected policyholders about the implications for them of the proposed changes;
Give affected policyholders access to further information (beyond that in the communications pack);
Let affected policyholders know how to object to the proposed changes;
Maintain customers‟ confidence in MSIEu and, if the Scheme is sanctioned, MSIG AG to continue
to meet their obligations under transferring policies and non-transferring policies; and
Meet legal and regulatory requirements.
5.32. I comment on this proposed approach to communications with policyholders in Section 10.
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6. GENERAL CONSIDERATIONS OF THE INDEPENDENT EXPERT
Introduction
6.1. I have compiled my report in accordance with Chapter 18 of the Supervision Manual of the PRA
Handbook/FCA Rules.
6.2. Under the PRA Handbook/FCA Rules, the concept of the fair treatment of customers should be applied. To
help ensure that customers are treated fairly in the future it is necessary to understand how they have been
treated in the past. From the policyholders‟ perspective, the acceptability of the Scheme must be on the
basis that it will not have a materially adverse effect on their benefits or fair treatment.
6.3. I need to consider the terms of the Scheme generally and how the different groups of policyholders are likely
to be affected by the Scheme and, in particular:
The effect of the Scheme on the security of the policyholders‟ contractual rights, including the
likelihood and potential effects of the insolvency of the insurer; and
The likely effects of the Scheme on policyholder servicing levels (e.g. claims administration).
6.4. As described in Section 5 of this Report, there are 2 insurance companies involved in the Scheme, MSIEu
and MSIG AG, each of which has a different mix of business.
6.5. It is therefore important that I consider whether this change in the size and nature of the company will have
any impact on the security of benefits or reasonable expectations of affected policyholders.
6.6. The main factors that determine the risks to which a policyholder is exposed are:
Size of company;
Amount of capital held, other calls on that capital and capital support currently available to the
company;
Reserve strength;
Investment strategy;
Mix of business written; and
Company strategy – for example, whether it is open or closed to new business.
Security of Policyholder Benefits
6.7. As part of my role as Independent Expert for the Scheme, I need to consider the security of policyholder
benefits; that is, the likelihood that policyholders will receive their benefits when due, e.g. the payment of
claims.
6.8. In considering and commenting upon policyholder security I shall consider the financial strength of each
entity. Financial strength is provided by the margins for prudence in the assumptions used to calculate the
Technical Provisions, by the shareholder capital and by any specific arrangements for the provision of
financial support. In considering policyholder security it is also necessary to take into account the potential
variability of future experience (including claim frequency and severity). Security is also affected by the
nature and volume of future new business.
6.9. The nature of the assets which constitute each company‟s capital and surplus is also relevant. The
shareholder is able to withdraw surplus shareholder assets (i.e. retained profits, but not share capital) in the
form of realised profits, provided minimum capital requirements are met. The security provided by such
assets may therefore be temporary.
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Policyholder Servicing Levels
6.10. SUP 18.2.36 requires me, as Independent Expert, to consider the likely effects of the Scheme on
policyholder benefit expectations.
6.11. This includes consideration of the likely effects of the Scheme on matters such as corporate governance,
claims management, investment management, new business, administration, expense levels and valuation
bases impacting levels of service to policyholders.
FCA Conduct Principles
6.12. As Independent Expert for the Scheme I need also to consider the proposals in the context of the FCA‟s
conduct principles and in particular the impact on levels of service provided to policyholders.
6.13. This involves consideration of areas where discretion is involved on behalf of the relevant insurance
company with regard to charges applied to a policy and the benefits granted to the policyholder, and also to
service standards applied.
Consumer (Policyholder) Protection
6.14. Further, as Independent Expert for the Scheme I need also to consider the proposals in the context of
consumer protection and in particular the impact on policyholders in the event of the default of an insurer,
and the resolution of complaints between an insurer and its customers (policyholders).
6.15. This involves consideration of the protection afforded to policyholders of the relevant insurance company
with regard to compensation granted to such policyholders in the event of the default of the insurer, and/or
the resolution of complaints between the insurer and its policyholders.
Development of the Scheme
6.16. In the following sections I comment on the Scheme as it will be presented to the Court. During the
development of the proposed terms of the Transfer I have commented on drafts of the Scheme.
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7. THE EFFECT OF THE SCHEME ON THE TRANSFERRING POLICYHOLDERS
Introduction
7.1. Under the Scheme, some of the (re)insurance business of MSIEu will be transferred to MSIG AG.
7.2. The main issues affecting the transferring policyholders of MSIEu as a result of the Scheme arise from
relative differences in:
The financial strength of MSIG AG after the transfer compared to that of MSIEu currently. Financial
strength is derived from the strength of the reserves held, excess assets or capital, and specific
capital support arrangements (and the calls on that capital support);
The risk exposures in MSIG AG compared to those in MSIEu;
The policy servicing levels provided by MSIG AG after the transfer compared to those enjoyed by
the policyholders of MSIEu currently.
7.3. In this section I address each of these issues.
The Change in Financial Strength due to the Scheme
RESERVE STRENGTH OF MSIEU (PRE TRANSFER)
7.4. I have been provided with internal (and external) actuarial analyses on the technical reserves of MSIEu as at
31 December 2012, the process by which the reserves are established and details of the internal and
external actuarial reviews which have been performed. I have also discussed the processes and key issues
arising from the reviews with the relevant actuaries.
7.5. I have reviewed the work carried out by the relevant actuaries, in order to satisfy myself that it is reasonable
for me to rely on their work. This included reviewing the reports produced by the relevant actuaries and
assessing the appropriateness of the methodologies and major assumptions used.
7.6. I have not attempted to review in detail the calculations performed by the internal (or external) actuaries.
Instead I have reviewed the process by which reserves are set, the approach followed by the internal
actuaries, the key areas of reserve uncertainty and the apparent strength of the reserves.
7.7. The internal actuaries have produced a largely TAS R compliant report describing the approach adopted and
the results produced (including incurred development patterns for the main segments of business – see
paragraph 7.8 below) from their reserving study as at 31 December 2012.
7.8. The internal actuaries have used generally accepted actuarial methods to estimate reserve requirements. In
broad terms they have used:
A granular approach to segmenting the data, namely splitting the book by: JIA and non-JIA
business; fronted and non-fronted arrangements; branch; class of business and Underwriting Year
and Accident Year;
Loss development factors based mostly on the gross claim development history of MSIEu. Where
required, adjustments are made to the projections particularly when large or unusual contracts
materially distort the development of a reserving class. Further, where a reserving class had limited
historical development to rely on, benchmark patterns7 were also considered;
Initial expected loss ratios based on business plan loss ratios, historical loss ratios, and
discussions with the underwriting and claims personnel of MSIEu;
Net estimates were, in general, derived from the corresponding gross estimates using gross to net
ratios taking account of specific reinsurance programmes in the various classes (e.g. fronting
arrangements);
7 Benchmark patterns are loss development factors based on market experience and data. Benchmark-based patterns may be used where the insurer has limited claims experience applicable to the business to be projected.
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Reinsurance recoveries arising from the estimates of gross IBNR for the German and French non-
JIA Liability business were determined differently to the rest of the business, and based on external
analysis from a large broking house as follows:
o Large loss modelling on the whole of the non-JIA account based on benchmarks for
similar portfolios with frequency and severity modelled separately. Gross losses are
simulated and netted down using the MSIEu reinsurance programme;
o The expected reinsurance recovery percentages derived from the external analysis are
then applied to the MSIEu gross IBNR to arrive at a net IBNR.
7.9. The reserves estimated by the internal actuaries as outlined in paragraph 7.8 above are stated to be on a
best estimate basis, defined as the mean of the expected value of a range of possible outcomes of the
outstanding claims in the context of the data available for the analysis. The aforesaid analysis does not
include an allowance for binary events (i.e. very extreme high severity low probability claims that have not
been evidenced in the historical data). I interpret this measure to be on a basis greater than a 50%
confidence level (as the claim distribution is expected to be positively skewed8).
7.10. The other “live” reserve class relates to the GAUM business, where gross reserves have been set with
reference to an external actuarial review commissioned by GAUM (to which I have had access). The net
reserves are booked as zero as the business is 100% reinsured to MSIJ (see paragraph 3.16 above).
7.11. For the run-off reserve classes, MSIEu has reserved the business as at 31 December 2012 as follows:
No IBNR has been established for the WFUM pool scheme as the bar date for the scheme of
arrangement was in April 2008, and the scheme is now complete in respect of all creditors;
The old Sumitomo account has an IBNR of £3.7m gross and £1.1m net based on a review
undertaken by an external run-off consultant. The US APH claims and exposures are small and the
same gross and net reserves were held as at year-end 2011. Based on there having been no
recent claims development this reserve does not appear unreasonable;
The BDM account has a reserve of £1.3m gross and £0.1m net, compared to £2.8m gross and
£0.2m net as at year-end 2011, which appears reasonable given the lack of recent claims
development and the reinsurance in place.
7.12. The estimation of reserve requirements for insurance business is an inherently uncertain exercise. The key
sources of uncertainty for MSIEu are: longer-tailed claims in general, particularly from the JIA UK Employers
Liability class that also has exposure to latent disease claims; and the volatile nature of the non-JIA business
written by the German and French branches, i.e. industrial excess-of-loss risks with small premium volumes
(compared to market peers). However, the volatility to MSIEu of the non-JIA business written by the German
and French branches had essentially been mitigated by purchasing robust and protective treaties, and has
been reduced to zero post 1 October 2012 (on a net of reinsurance basis) as a result of the reinsurance
arrangement with MSIJ that cedes 100% of all liabilities to MSIJ (see paragraph 3.19 above).
7.13. Where appropriate I have compared the results of the internal actuary‟s work with my own broad
assessments based on the application of benchmark factors derived from my knowledge of similar books of
business.
7.14. Based on my review of the reserve study as at 31 December 2012 (as carried out by the internal actuaries) I
am satisfied that the methodologies, major assumptions and results are reasonable.
7.15. The earned outstanding claims reserves held by MSIEu are based on the internal actuaries‟ best estimate
reserves plus a management loading of £4.8 million to provide an allowance for the various sources of
uncertainty surrounding the best estimate reserves. In addition, within the outstanding claims reserves,
MSIEu held a provision of £3.9 million for claims handling expenses determined on a percentage of gross
outstanding claims basis, by reference to average expenses payable on underlying claim payments.
8 A claims distribution of potential losses is said to be positively skewed as the loss cannot be less than zero, but can be many times larger than the
average loss (alternatively, this may be viewed as a distribution of potential losses having a higher frequency of lower value losses, and a lower frequency of higher value losses, e.g. observed losses of: 1, 2, 3, 4, 100).
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7.16. Based on my review above, I consider the (earned) claims outstanding reserves of £243.5 million (gross of
reinsurance) and £68.1 million (net of reinsurance) held by MSIEu as at 31 December 2012 to be on a basis
stronger than a 50% confidence level.
7.17. Of the total MSIEu Technical Provisions9 of £287.2 million (gross of reinsurance) and £75.9 million (net of
reinsurance) as at 31 December 2012, £41.6 million (gross of reinsurance) and £5.7 million (net of
reinsurance) related to unearned premiums. The provision for unearned premiums is determined on a
straight line basis over the term of the policies for all classes of business. I believe the method adopted by
MSIEu for the calculation of provisions for unearned premiums to be in line with normal market practice.
7.18. MSIEu is heavily exposed to reinsurance recoveries from its parent MSIJ. As at 31 December 2012, MSIEu
had overall ceded Technical Provisions of £211.3 million, of which over 75% was in respect of anticipated
reinsurance recoveries arising from reinsurance arrangements with MSIJ. MSIEu makes a small allowance
for reinsurance bad debt (circa £300k as at 31 December 2012) on the basis that MSIJ has an A+ financial
strength rating by Standard & Poor‟s and only external reinsurers with a rating of A- or better are used by
MSIEu in general. Given the aforesaid financial strength ratings and the management loading (see
paragraph 7.15 above) this approach is in my view not unreasonable.
7.19. MSIEu does not reflect the time value of money in its claims reserves. This gives rise to an off balance sheet
asset (safety margin) equivalent to the time value of money inherent in the undiscounted reserves. Such a
safety margin increases the security of the policyholders to the extent that it is not required to help meet
other commitments such as run-off administration costs.
7.20. An external actuarial review was also performed on the MSIEu liabilities as at 31 December 2012 for the
purposes of providing, as warranted, an actuarial opinion for the International Insurers Department (IID)
regulatory requirements in the USA covering the company‟s worldwide Technical Provisions.
7.21. The external actuaries have produced a report in accordance with and reflecting the principles contained
within actuarial standards TAS-R, TAS-D, TAS-I and TAS-M. The report describes the approach adopted
(and the results produced) from their reserving study as at 31 December 2012.
7.22. The external actuaries have used generally accepted actuarial methods to initially estimate reserve
requirements, gross and net of reinsurance, based on data as at 30 September 2012. They then analysed
the actual claim (and premium) movements between 30 September 2012 and 31 December 2012 against
their expectations as at 30 September 2012 and made adjustments to their estimates, where appropriate, in
order to produce their estimate as at the 2012 year-end.
7.23. For the purposes of their projections (made using standard actuarial methods) the external actuaries
grouped certain classes and performed independent projections on these. In determining their reserve
estimates, they have also considered benchmarks and alternative approaches adopted in the market. In
addition, they have stripped out large losses and catastrophe claims from their projections where these
would otherwise distort the results. They have then made separate allowances for these events. To
determine their net results, the external actuaries have applied gross-to-net ratios with reference to the
MSIEu reinsurance programme and paid and incurred information.
7.24. The gross analysis performed by the external actuaries was based upon the data available with the JIA book
analysed firstly on an Underwriting Year basis and then converted to an earned, Accident Year basis.
Whereas, for the non-JIA book the external actuaries projected the figures directly on an Accident Year
basis. Reinsurance recoveries on an earned basis were then taken into account to produce their net
estimates on an Accident Year basis.
7.25. I am satisfied that the methodologies, major assumptions adopted by the external actuaries as at
31 December 2012 and the results so generated appear reasonable.
7.26. The reserves estimated by the external actuaries are stated to be on a best estimate basis, i.e. they
represent the expected value of the range of possible outcomes. I interpret this measure to be on a basis
greater than a 50% confidence level (as the claim distribution is expected to be positively skewed).
9 Source: Forms 13 and 15 of MSIEu's return to the FSA as at 31 December 2012 (Technical Provisions include an Equalisation Provision of £2.1
million).
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7.27. As at 31 December 2012, the external actuaries (commissioned by MSIEu) estimated an outstanding claims
reserve surplus net of reinsurance (excluding reinsurance IBNR bad debt, claims handling expenses and
Equalisation Provisions) against the corresponding internal actuarial figures of £1.5m, but a surplus against
the booked outstanding claims reserve of £6.4m due to the management margin held by MSIEu (see
paragraph 7.15 above). Therefore, the reserves calculated by MSIEu as at 31 December 2012 are (equal to
or) above the reserves the external actuaries have calculated using accepted actuarial reserving
approaches. Thus, on the basis of the work performed by the external actuaries, a statement of actuarial
opinion (SAO) to this effect was issued to the IID.
Conclusion
7.28. Overall, based on my review as described above concerning the Technical Provisions of MSIEu as at
31 December 2012, the reserves are reasonable at present.
RESERVE STRENGTH OF MSIG AG PRE TRANSFER
7.29. I have been provided with the reserving analysis report for MSIG AG as at 31 December 2012 providing a
split of the claims reserves by business line and a description of the approach taken to reserving for each
line.
7.30. As at 31 December 2012, MSIG AG reported Technical Provisions of €3.9m (gross of reinsurance) and
€1.7m (net of reinsurance). Table 7.3 below shows a breakdown of MSIG AG‟s Technical Provisions (gross
of reinsurance), as shown in its Annual Report as at 31 December 2012.
Table 7.3 MSIG AG Technical Provisions as at 31 December 2012
7.31. As shown in Table 7.3 above, MSIG AG‟s principal lines of business are its direct Property, Liability,
Engineering and Hull accounts. It also has a relatively large inwards reinsurance account.
7.32. The UPR (gross of reinsurance) has been determined using a daily (1/365ths
) earnings basis, while the
ceded UPR also reflects deferrals as per contractual agreements. The claims outstanding reserves for
reported claims on direct business have been determined individually on an expected basis, while the IBNR
provision has been determined on the basis of the expected future reporting of incurred claims (see
paragraph 7.34 below).
7.33. For inwards reinsurance business the Technical Provisions were based on the information supplied by the
primary insurers. Where information was not available at the balance sheet date, the reserves were
estimated on the basis of expert judgement/experience (the impact of which is immaterial as at 31
December 2012).
€000s Gross UPRGross Claims
Outstanding
Property 1,095 286
Liability 1,200 73
Engineering 325 0
Hull 284 197
Inwards Reinsurance 407 16
3,311 572
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7.34. Due to the lack of historical claims experience, the company used the Expected Loss10
approach (based on
the initial German Branch loss ratios) in all cases except the Scandinavian marine business where it applied
a Bornhuetter Ferguson approach (with the actual German Branch development pattern). Further, a
proportional reinsurance approach (based on the company‟s quota share arrangements) has been applied to
determine net reserve estimates. In addition, the company have included a management loading of €100k
(gross and net).
7.35. MSIG AG is exposed to very large gross losses from both the Property and Liability lines, but as outlined in
Section 4 above, through its reinsurance arrangements with MSIJ (and other external reinsurers) its net
exposures are limited.
7.36. MSIG AG first estimates its reserves on a best estimate basis. I interpret this measure to be on a basis
higher than a 50% confidence level (as the claim distribution is expected to be positively skewed). In
addition, MSIG AG have estimated German GAAP outstanding claim reserves (as shown in Table 7.3
above) by applying a 15% loading to its best estimate IBNR reserves (which I denote as a “conservative”
best estimate).
7.37. I have reviewed the actuarial and other analyses made available to me by MSIG AG and have discussed the
liabilities and approach to reserving with key MSIG AG personnel, including outsourced resources.
7.38. I am satisfied that the methodologies, major assumptions and results of the actuarial and other analyses
used by MSIG AG to set reserves as at 31 December 2012 appear reasonable.
7.39. MSIG AG does not reflect the time value of money in its claims reserves. This gives rise to an off balance
sheet asset (safety margin) equivalent to the time value of money inherent in the undiscounted part of the
reserves. Such a safety margin increases the security of the policyholders.
7.40. As outlined in paragraph 2.34 above, MSIG AG is required to establish and maintain an Equalisation
Provision in accordance with HGB accounting (German GAAP) principles that are typically more “onerous”
than those applicable to Equalisation Provisions in the UK. Nonetheless, a zero provision was held by MSIG
AG as at 31 December 2012 on the basis that the company had just commenced underwriting.
Conclusion
7.41. Overall, based on my review as described above as at 31 December 2012, the reserves of MSIG AG
appear reasonable at present.
MSIG AG RESERVE STRENGTH POST TRANSFER
7.42. The main risk to consider is the risk that the liabilities of the transferring policies, or of MSIG AG, deteriorate
post-transfer to such an extent that MSIG AG‟s solvency is threatened. This event could disadvantage
policyholders of MSIG AG and/or the transferring policyholders of MSIEu that might have remained secure
had the transfer not taken place.
7.43. Technical Provisions in respect of the continental European branch liabilities to be transferred under the
proposed Scheme were assessed by the MSIEu internal actuaries at £154.8m (gross of reinsurance) and
£40.9m (net of reinsurance) as at 31 December 2012 on a best estimate basis, including an appropriate
proportionate share of the management loading (see paragraph 7.15 above).
7.44. The external actuary (retained by MSIG AG) has also assessed the outstanding claims reserves in respect
of the continental European branch liabilities to be transferred under the Scheme (on the assumption that
the transfer took place as at 31 December 2012) on both best estimate and conservative best estimate
bases. This analysis indicates that the results generated on a best estimate basis were consistent with the
best estimate results developed by the internal actuaries of MSIEu. As a result, the conservative best
estimate Technical Provisions developed for MSIG AG would be very similar to the Technical Provisions in
respect of the continental European branch liabilities to be transferred under the proposed Scheme (as
outlined in paragraph 7.43 above).
10
Expected Loss approach produces an estimate of ultimate claims by multiplying the earned premiums by an assumed loss ratio. To minimise bias the assumed (a priori) loss ratios are usually selected by examining the past experience of the account and explicitly adjusting this for known premium rate changes, inflation and other changes in policy terms and conditions.
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7.45. I am informed that the reserving basis adopted by MSIG AG after the Effective Date will continue to be on a
conservative best estimate basis. I am satisfied, therefore, that the reserving levels adopted by MSIG AG
after the Effective Date will continue to be on a basis that is stronger than a 50% confidence level and
designed to produce a positive outstanding claims reserve run-off.
7.46. As described above, I have reviewed the actuarial work carried out internally (and externally) on the reserves
of MSIEu and MSIG AG as at 31 December 2012 (and other valuation dates). The conclusions of my
reviews on reserve strength are also described above.
7.47. On the basis that the relevant outwards facultative reinsurance contracts of MSIEu are transferred to MSIG
AG and the relevant outwards treaty reinsurance contracts accede to endorsement, as described in Section
10, the net (of reinsurance) position of MSIG AG post the transfer should not be adversely impacted as a
result of the Scheme.
7.48. As mentioned in paragraph 7.40 above, MSIG AG post transfer (the “combined entity”) will be required to
establish and maintain an Equalisation Provision in accordance with German GAAP principles. MSIG AG
has estimated that an Equalisation Provision of circa €30 million will be required by the combined entity as
at 31 December 2013 (allowing for the receipt of the transferred portfolio from MSIEu), i.e. as at the planned
Effective Date, in order to satisfy German GAAP principles on such provisions. It should be noted that by
their nature Equalisation Provisions act as cushion against periods of worse than expected claims
experience, and may therefore be considered as pseudo capital. Indeed under Solvency II, Equalisation
Provisions are no longer permitted (and would therefore form part of a company‟s capital).
7.49. I have reviewed the assessment of the estimated Equalisation Provision of circa €30 million as at 31
December 2013, and confirm that estimated provision is not unreasonable based on the data provided to
me.
7.50. I have received a draft Letter of Intent from MSIJ, whereby it undertakes to ensure additional funds of €30m
over and above the assets (matching the liabilities) transferred under the Scheme into MSIG AG on or prior
to the Effective Date. Figure 7.1 below sets out the cash-flows between the relevant entities and the timeline
for the €30m of additional assets to be transferred into MSIG AG. In this manner the Available Capital (see
paragraph 7.56 below) of MSIG AG on the Effective Date (as measured under Solvency I) will not be
impacted by the Scheme. It should be noted that there is no requirement for an Equalisation Provision under
Solvency II, and as such the assets backing the Equalisation Provision will form part of the Own Funds
(Available Capital in Solvency II terminology) of MSIG AG, but only when Solvency II is implemented.
Therefore, at the Effective Date the €30m capital injection cannot be considered as Available Capital as it
will be required to match the Equalisation Provision established.
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Figure 7.1
Cash Flows between Entities and the Timeline for the Injection of Additional Funds into MSIG AG
7.51. In addition, I have received a Letter of Intent from MSIGHE signed by Mr K Fukuhara, Chairman and Chief
Executive Officer, and also an executive officer of MSIJ, that commits to maintain the capital position of
MSIEu at the level projected at the Effective Date (as per the current 2013 Business Plan for MSIEu) for a
period of six months following the Effective Date, and to make a single payment of €30 million to MSIEu no
later than the date being at least five (5) business days prior to 13 December 2013 (or such later date, which
is the date of the final court hearing in respect of the Transfer).
7.52. I take comfort from the Letters of Intent for the following reasons:
The Letters of Intent are to be formalised by the Boards of MSIJ and MSIGHE (as the immediate
parent companies of MSIG AG and MSIEu respectively) via appropriate Board resolutions. In this
manner the undertaking to provide additional funds of €30m to MSIG AG and maintain the capital
position of MSIEu cannot be disregarded without any proper consideration by the appropriate
Board. In addition, I expect any proposed changes to, or deviations from, Board resolutions in the
future would be of interest to the PRA/FCA and/or BaFin as appropriate;
MSIG AG will be the flagship risk carrier in continental Europe for MS & AD and so there is unlikely
to be any material dilution of its solvency due to its critical role in MS & AD.
7.53. I will comment further on this aspect of the financial position of MSIG AG (and, as appropriate, that of
MSIEu) if it would affect my overall opinion, and report on this matter as part of my supplementary/update
report (see paragraph 1.26 above).
7.54. Overall, therefore, I would expect MSIG AG to be reasonably reserved after the Effective Date.
Conclusion
7.55. I believe that the Scheme will not have a materially adverse effect on the reserve strength provided to
the transferring policyholders of MSIEu compared to both their current position and their projected
position at the Effective Date.
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August 23, 2013 34
EXCESS ASSETS
7.56. For the purposes of my comparative analysis of the excess assets/capital levels of MSIEu and MSIG AG pre
and post the proposed Transfer, I have considered the extent to which each company holds capital in excess
of its regulatory solvency level, in which case the actual capital that the company under consideration holds
(the “Available Capital”) will be greater than the “Required Capital” calculated. I refer to the ratio of Available
Capital to Required Capital as the “Capital Cover Ratio”. For the purposes of the terms I use in this Report, a
company with sufficient capital (relative to the regulatory capital requirement under consideration) will have a
Capital Cover Ratio just greater than 100%. I describe a company as well capitalised if it has a Capital Cover
Ratio greater than 150%, and very well capitalised if it has a Capital Cover Ratio in excess of 200%.
7.57. If the Capital Cover Ratio increases after the Transfer for a group of policyholders, then there is an increase
in security for those policyholders. If the Capital Cover Ratio reduces then there is a reduction in security and
I need to consider whether the reduction is likely to be material to those policyholders.
7.58. I have used the Required Capital produced by the MCR, ECR, ICA, ICG and proto-type Solvency II standard
formula exercise (QIS5) results (as appropriate) in order to calculate the Capital Cover Ratios, pre and post
Transfer for different groups of policyholders. I have used these Capital Cover Ratios to understand the level
of policyholder security post Transfer and to compare the levels pre and post Transfer:
For transferring MSIEu policyholders, this enabled me to understand their level of security if the
Transfer is approved;
For MSIG AG policyholders, this enabled me to understand not just their level of security if the
Transfer is approved, but additionally how this compares against the level of security if the Transfer
is not approved;
For non-transferring MSIEu policyholders, this enabled me to likewise understand not just their level
of security if the Transfer is approved, but additionally how this compares against their level of
security if the Transfer is not approved.
7.59. I comment further on these levels of security in the paragraphs below. I discuss the Capital Cover Ratios in
qualitative (and where appropriate quantitative) terms that I believe to be appropriate to explain the
implications for policyholder security.
EXCESS ASSETS OF MSIEU (PRE TRANSFER)
7.60. As at 31 December 2012 the policyholders of MSIEu enjoyed the security of capital resources (i.e. Available
Capital) as measured in MSIEu‟s 2012 FSA return of £121.3 million compared with Required Capital of
£17.2 million. The Solvency I (MCR) Capital Cover Ratio was therefore 7.1 (Available Capital divided by
Required Capital), i.e. the company was very well capitalised (relative to its MCR). The free assets of the
company were equal to £104.1 million (i.e. Available Capital less Required Capital).
7.61. On an Enhanced Capital Requirement (“ECR”) basis (a more risk sensitive and targeted capital requirement
than the MCR), the policyholders of MSIEu also enjoyed a good level of surplus of Available Capital relative
to Required Capital (ECR) as at 31 December 2012. In qualitative terms the Capital Cover Ratio for the
company indicated that it was very well capitalised as at 31 December 2012 (relative to its ECR).
7.62. In line with regulatory requirements, MSIEu has made an Individual Capital Assessment (“ICA”) of its capital
needs. MSIEu has made available to me its most recent ICA, undertaken as at 31 December 2012, as well
as the previous ICA undertaken as at 31 December 2011. The 2012 ICA has been prepared on two bases:
one reflecting the actual position as at 31 December 2012, the other on the assumption that the 100% non-
JIA reinsurance arrangement with MSIJ was not in place. In each case the ICA estimates the amount of
capital required in order to maintain its ability to meet its obligations with a 99.5% confidence interval over a
(new business) time horizon of one year.
7.63. The ICA sets out the risks to which MSIEu is exposed and MSIEu‟s approach to modelling the risks for
quantifying the ICA, and its approach to managing risks more generally.
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7.64. The main areas of risk to which MSIEu is exposed are summarised in Section 3 (see paragraphs 0 – 3.26
above). MSIEu commissions external actuaries to help evaluate its ICA. I have been provided with the
external actuaries‟ draft reports on the ICA as at 31 December 2012 and the ICA for the business retained
post the Scheme (assuming the proposed transfer took place as at 31 December 2012).
7.65. The ICA is a complicated process that relies on an assessment of the risks in the business, extensive
modelling and management judgement to determine an appropriate figure. I have reviewed the internal ICA
document made available to me by MSIEu. It describes the work conducted in order to make the
assessment, including a discussion of the risks to which MSIEu is subject in the course of its business. I
have also discussed the results and assumptions used with key personnel at MSIEu.
7.66. I have considered the appropriateness of the methodology and modelling techniques used. I have also
considered the reasonableness of the key assumptions used in the calculations and the results of these
calculations. In assessing the reasonableness of the methodology, assumptions and results, I have also
considered how they compare against my knowledge of the market.
7.67. There are a number of key risks identified in MSIEu‟s ICA. The most significant categories of risk (listed in
order of their contribution to the ICA) are insurance (reserving and underwriting), market, operational/group
and credit risks:
The insurance risk (including the risks associated with exposures to: reserving for long-tail claims;
the insurance cycle and insufficient pricing margins; and catastrophe losses arising from
windstorms, flooding and winter freezes) is significantly the biggest contributor to the ICA, although
the volatility from non-JIA business is essentially eliminated at a net level by the 100% non-JIA
reinsurance with MSIJ;
The market risk arises mainly from asset/liability mismatch and fluctuations in exchange rates (in
particular, movements in the £/€ exchange rate);
The operational/group risk arises mainly from failure of controls and contagion risks arising from
one or more of the other MS & AD companies;
The credit risk arises mainly from the heavy exposure to reinsurance recoveries from MSIJ (in
particular the 100% non-JIA reinsurance).
7.68. A key set, indeed the most material set, of assumptions employed in deriving the ICA amount are the
correlations used for obtaining the diversification benefits within major risk categories (i.e. an allowance for
the benefit that not all the risks within a risk category will deteriorate at the same time), and also when
aggregating key risks (i.e. an allowance for the benefit that not all major risk categories will deteriorate at the
same time). The next most material assumptions are the volatilities employed for reserve risk.
7.69. The derivation of the various correlation assumptions is largely a judgemental exercise, because of a lack of
historical data. Based on my high-level review of the various correlation matrices, the assumptions adopted
by MSIEu for ICA purposes appear broadly reasonable. However, this is an area where significant
judgement is used, and as such considerable uncertainties surround the assessment of the diversification
benefits utilised in deriving the ICA amount.
7.70. MSIEu has undertaken a number of tests to validate their ICA including:
Benchmarking the results against the market on various measures;
Sensitivity/scenario tests on the assumptions to identify the significant assumptions;
Discussions with the underwriting and claims teams as to the efficacy of the parameters employed
for underwriting and reserve risk;
Comparing the ICA against stress and scenario tests to assess its robustness; and
Reconciliation of the modelled (central) results with the business plan.
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7.71. I consider the methodology and modelling techniques used by MSIEu to be reasonable and in line with
current market practice for comparable companies. The assumptions used within any ICA calculation are to
a large extent a matter of judgement. My judgement is that the results provided as at 31 December 2012
appear reasonable, but I recognise that other results could have been generated using different sets of
assumptions that are within the bounds of reasonableness. Nonetheless, I would expect the results
generated using different sets of assumptions that are within the bounds of reasonableness, to still be below
the Available Capital (on an ICA basis) as at 31 December 2012.
7.72. Nothing emerged from my review of the ICA documents or my discussions to give me concerns as to the
financial strength of MSIEu, or to conclude that the ICA does not form a reasonable basis for assessing the
capital requirements of MSIEu, in particular, the level of capital required so that the company can meet its
obligations to the level of confidence specified by the PRA/FCA for general insurance companies.
7.73. Based on its ICA as at 31 December 2012, MSIEu had Available Capital comfortably in excess of its (ICA)
Required Capital (both allowing for and excluding the 100% non-JIA reinsurance arrangement with MSIJ),
i.e. the Capital Cover Ratio for the company indicated that it was well-capitalised (relative to its ICA).
7.74. The PRA provides individual capital guidance (“ICG”) to MSIEu. This guidance sets out the results of the
PRA‟s review of the ICA and the minimum level of capital that it would expect MSIEu to hold based on its
view of the ICA and the risk management framework of MSIEu. The ICG is intended to target the same level
of confidence as described above for the ICA, but it represents the PRA‟s view rather than that of MSIEu.
The ICG is typically set as a percentage of the ECR. I have been provided with a copy of a letter dated 7
July 2011 from the FSA to MSIEu confirming the level of ICG (which has not yet been the subject of revision
by the PRA).
7.75. Due to limitations on the degree of disclosure permitted by the PRA, I am not able to provide details of
MSIEu‟s ICA or ICG figures in this Report. Nonetheless, the Available Capital of MSIEu was in excess of its
(ICG) Required Capital as at 31 December 2012 (on the basis that ICG as at 31 December 2012 remained
at the same percentage of ECR as previously confirmed to MSIEu by the FSA in 2011). In qualitative terms
the Capital Cover Ratio for the company indicates that it is well capitalised (relative to its ICG).
7.76. In addition, the Finance department (with assistance from the Actuarial department who supplied the proto-
type Solvency II technical provisions and performed the Catastrophe module calculations) of MSIEu
undertook a proto-type Solvency II standard formula exercise as at 31 December 2012 (based on QIS5 as
outlined from paragraph 10.60 below) and produced Required Capital, i.e. an indicative Solvency Capital
Requirement (“SCR”) of £92.4 million relative to Available Capital (Own Funds) of £123.7 million. I have
reviewed the approach and calculations undertaken by the finance team and internal actuaries and the key
assumptions they have employed (see paragraph 10.66 below for further details). My review has led me to
conclude that the methodology and assumptions employed by the finance team/internal actuaries form a
reasonable basis for determining the SCR for MSIEu using the proto-type Solvency II standard formula. The
SCR so determined showed that the Available Capital of MSIEu as at 31 December 2012 exceeded the
SCR, and the Capital Cover Ratio for the company was 1.3, i.e. it was more than sufficiently capitalised
(relative to its SCR).
Conclusion
7.77. Overall, based on my review as described above concerning the excess assets of MSIEu, I believe
the policyholders of MSIEu, including those transferring to MSIG AG under the proposed Scheme,
currently enjoy the level of security afforded by a well-capitalised company.
EXCESS ASSETS OF MSIG AG (PRE TRANSFER)
7.78. MSIG AG is required to maintain capital at least equal to the Solvency I Minimum Capital Requirement at all
times, as well as covering liabilities assessed on a prudent basis. Failure to meet this obligation (referred to
as the statutory or “Solvency I” capital requirement) is likely to lead to regulatory intervention.
7.79. On a Solvency I basis, the policyholders of MSIG AG enjoyed the security of capital resources (i.e. Available
Capital) as at 31 December 2012 of €80.2 million compared with Required Capital of €3.5 million. The
Solvency I (MCR) Capital Cover Ratio was therefore 22.9 (Available Capital divided by Required Capital),
i.e. the company is very well capitalised (relative to its MCR) as at 31 December 2012. The free assets of the
company were equal to €76.7 million (i.e. Available Capital less Required Capital).
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7.80. The ratio of free assets to net technical provisions, i.e. €76.7 million † €1.7 million, is 45.1, i.e. net technical
reserves could increase by a factor of 45 from their current level before MSIG AG's free assets were
exhausted.
7.81. As mentioned in paragraph 7.35 above, MSIG AG is exposed to reinsurance recoveries. Absent other losses
(including increased amounts on existing claims) the company could sustain bad debts in respect of the
whole of the amounts owed by reinsurers and anticipated recoveries without exhausting its free assets.
7.82. MSIG AG‟s Available Capital (essentially shareholder‟s funds) is unusually large in proportion to its MCR
(and Technical Provisions) because the company only started writing business towards the end of the 3rd
quarter 2012 (with €4.2 million of gross premium income written in 2012).
7.83. MSIG AG is required to establish and maintain an Equalisation Provision in accordance with HGB
accounting (German GAAP) principles (these are typically more “onerous” than those in the UK). A provision
of circa €30 million is anticipated to be required as at the Effective Date.
7.84. While not a regulatory requirement at the date of this Report, MSIG AG has estimated its SCR using the
proto-type Solvency II standard formula as at 31 December 2012 (based on QIS5, i.e. calibrated to a
confidence level of 99.5% over a one-year time horizon). I have reviewed the company‟s calculations and
assessed the amount to be approximately €30 million. This capital assessment is comprised of three major
components as follows:
Insurance risk arising from the adverse development on claim and premium reserves, inadequate
premiums on future business and catastrophe losses which contributed approximately 62% to the
overall undiversified SCR;
Counterparty risk arising primarily from Risk Mitigation for ceded natural catastrophe exposures (which
is required due to the calibration of the Catastrophe module on a net of reinsurance basis), the default
risk on bank deposits and to a lesser extent other reinsurance contracts. Counterparty risk contributed
38% to the overall undiversified SCR; and
Operational risk arising from inadequate or failed internal processes, people, systems or external
events, which contributed a small amount to the overall undiversified SCR (based on the simple
formulaic approach used in the standard formula).
7.85. Therefore, on a proto-type Solvency II standard formula basis (a much more risk sensitive and targeted
capital assessment than the MCR), the policyholders of MSIG AG enjoyed the security of Available Capital
(i.e. Own Funds in Solvency II terminology) as at 31 December 2012 of €80 million compared with a proto-
type Solvency II standard formula SCR (i.e. Required Capital) of approximately €30 million. The SCR Capital
Cover Ratio was therefore 2.7, i.e. Available capital ÷ Required Capital. On this basis the company was very
well-capitalised (relative to its SCR) as at 31 December 2012, while noting my comments in paragraph 7.82
above.
Conclusion
7.86. Overall, based on my review as described above concerning the excess assets of MSIG AG as at
31 December 2012, I believe the policyholders of MSIG AG enjoy the level of security afforded by a
well-capitalised company.
EXCESS ASSETS OF MSIG AG (POST TRANSFER)
7.87. As described above, MSIG AG post transfer (the “combined entity”) will be required to maintain capital at
least equal to its required MCR at all times.
7.88. On a Solvency I basis, the policyholders of the combined entity are forecast to enjoy Available Capital as at
31 December 2013 of €74.5 million relative to Required Capital (i.e. the projected MCR) of €13.3 million. The
Solvency I (MCR) Capital Cover Ratio is therefore forecast to be 5.6 (i.e. Available Capital ÷ Required
Capital), i.e. the combined entity is forecast to be very well capitalised (relative to its forecast MCR) as at 31
December 2013. The Solvency I free assets are forecast to equal to €61.2 million (i.e. Available Capital less
Required Capital).
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7.89. The ratio of projected free assets to projected net technical provisions is 69%, i.e. €61.2 million † €89.3
million. Therefore, the net Technical Provisions could increase by 69% from their projected 31 December
2013 level before the combined entity's projected free assets would be exhausted.
7.90. As to be expected and as mentioned above, the combined entity will be exposed to reinsurance recoveries.
Absent other losses (including increased amounts on existing claims) the combined entity could sustain bad
debts in respect of the whole of the amounts owed by reinsurers and anticipated recoveries without
exhausting its projected free assets (as at 31 December 2013).
7.91. At a high level, these figures indicate that the combined entity is very well capitalised relative to its forecast
Solvency I capital position. If the transfer takes place as planned as at 31 December 2013, the policyholders
of MSIEu transferring into MSIG AG would enjoy a projected Solvency I cover ratio of 5.6 compared to 7.1
pre-transfer (based on 31 December 2012 figures). Therefore, while their Capital Cover Ratio reduces and
there is a reduction in security on a Solvency I basis, I do not consider this reduction is likely to be material
to the MSIEu policyholders transferring to MSIG AG. Furthermore, it should be noted that the forecast
Solvency I capital position described above for the combined entity assumes that the benefit of the additional
funds of €30m (see paragraph 7.50 above) is neutral.
7.92. The Solvency I capital regime is much less risk-based than the proposed Solvency II capital regime, and that
currently operating in the UK through the ICA. In broad terms, the Solvency II capital regime is a risk-based
assessment of the capital requirements of an insurer over a one year time horizon, based on a likelihood of a
less than 0.5% probability of becoming insolvent (it is therefore not a dissimilar measure to that used by UK
insurers in making their ICA).
7.93. As described in Section 10, both MSIEu and MSIG AG are planning to use the standard formula under
Solvency II to determine their respective Solvency Capital Requirements. Until such time as Solvency II is
implemented the standard formula under QIS5 (as amended, supplemented or replaced at the time of
calculation) is widely considered to be close to what will be the standard formula approach for estimating the
level of capital for an insurer under Solvency II. QIS5 (as amended, supplemented or replaced at the time of
calculation) therefore provides, in my opinion, a reasonable risk-based capital framework against which to
measure the capital adequacy of MSIG AG post-transfer. It is also familiar to the regulators (the PRA and
BaFin), as well as the companies MSIEu and MSIG AG who have estimated their standard formula capital
requirements as at 31 December 2012.
7.94. As described in paragraph 7.76 above, MSIEu has estimated its SCR using the QIS5 standard formula as at
31 December 2012 (including the changes for eastern European flood risk catastrophe scenarios; and
diversification of non-EEA catastrophe scenarios arising from the more recent standard formula technical
specifications). It has also estimated its SCR using the QIS5 standard formula based on the Scheme having
been implemented on 31 December 2012. Using these two SCR calculations, and assuming the Scheme
had been implemented on 31 December 2012, I have estimated an approximate SCR for the Transferring
Business. I have further combined this amount with the SCR estimated for MSIG AG using the QIS5
standard formula as at 31 December 2012 (see paragraph 7.84 above) to give an approximate overall SCR
for the combined entity as at 31 December 2012 of €75 million. On the basis that the Scheme (and Solvency
II) had been implemented on 31 December 2012 and the additional funds of €30 million had been received
(see paragraph 7.50 above) the combined entity would have had own funds (Available Capital) that
exceeded its SCR. The Capital Cover Ratio for the combined entity would therefore be approximately 1.4,
i.e. more than sufficiently capitalised (relative to its SCR).
7.95. The estimation of the Capital Cover Ratio for the combined MSIG AG entity of approximately 1.4 is based on
a simplified approach; in particular a factor based approach for catastrophe risk (that does not model the
eastern European flood exposure separately or allow for diversification of non EEA scenarios) was adopted.
I have also made some rough calculations to estimate the impact of using a more sophisticated approach to
the calculation of catastrophe risk for the combined MSIG AG entity, which indicates that the Capital Cover
Ratio is projected to be in the range 1.2 – 1.4. I will revisit the calculation of the Capital Cover Ratio for the
combined MSIG AG entity and report on my findings in my supplementary report (see paragraph 1.26
above).
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7.96. The Capital Cover Ratio (on an SCR basis) for MSIEu as at 31 December 2012 is estimated to be
approximately 1.3. Therefore, the Capital Cover Ratio (on an SCR basis) is broadly unchanged for the
MSIEu policyholders transferring to MSIG AG, i.e. had the Scheme been implemented on 31 December
2012 and the combined entity received the additional funds of €30 million (see paragraph 7.50 above), the
MSIEu policyholders transferring to MSIG AG would neither suffer any reduction or enjoy any enhancement
in their security (measured on an SCR basis).
7.97. MSIG AG (in common with all other EEA insurers) is not under any obligation at the date of this Report to
meet the notional SCR under the current QIS5 standard formula (as amended, supplemented or replaced at
the time of calculation), which may in any event change before Solvency II is implemented. Nonetheless, it is
the intention of the senior management of MSIG AG (post-transfer) to operate a risk-based capital adequacy
test when considering a distribution after the implementation of the Scheme, until the earlier of 1 January
2019 and the introduction of Solvency II. Specifically, a Court order will be made as follows: "AND UPON
the Transferee [MSIG AG] by its Counsel undertaking that it will not until such time as the capital adequacy
regime to be implemented pursuant to Directive 2009/138/EC of the European Parliament and of the Council
on the taking up and pursuit of the business of Insurance and Reinsurance (Solvency II) is implemented in
Germany or, if earlier, 1 January 2019 pay dividends or make any other distribution in circumstances where
its eligible own funds (determined in accordance with guidance published by the competent European Union
body for the purposes of Solvency II current at the time of determination) are, or would as a result of such
dividend or distribution be, less than 100% of its solvency capital requirement (calculated in accordance with
the standard formula set out in the Fifth Quantitative Impact Study published by the Committee of European
Insurance and Occupational Pensions Supervisors (as amended, supplemented or replaced at the time of
calculation))”.
7.98. The Court order referred to in paragraph 7.97 above provides, in my opinion, an understandable, practical
and suitable means of assessing, when MSIG AG is considering a distribution, the (proto-type Solvency II
standard formula) solvency capital requirement for MSIG AG (post-transfer) in the period between the
Effective Date and the likely implementation of Solvency II (or 5 years if earlier). Furthermore, I note that:
On current timetables, it is expected that Solvency II will come into force prior to 2019. If so, the
Order covers the period between the Transfer and the beginning of Solvency II requirements on
MSIG AG. In this scenario, all future dividends or any other distributions will be subject to a post-
transfer test of capital based on risk – initially because of the Order and later via Solvency II;
If Solvency II is delayed beyond 5 years from the Effective Date then there would be a gap between
the expiry of the Order and the eventual onset of the Solvency II requirements. If any dividends or
other distributions were made during such a gap, the directors of MSIG AG would not be required to
apply a risk-based test to the post-transfer solvency position. I do not believe that the potential for
such a gap to arise means that the Scheme exposes the affected policyholders to a materially
increased risk for a number of reasons, in particular:
o by 2019 most of the affected policyholders will have had any claims settled and so would
no longer be exposed to the on-going solvency of MSIG AG;
o MSIG AG has a multi-year implementation program presently structured for the adoption
of Solvency II by the beginning of 2016. Therefore, even if the expected Solvency II in-
force date were to be delayed beyond 1 January 2019, I would expect that the MSIG AG
internal capital allocation process would resemble the anticipated Solvency II regime by 1
January 2019 such that any dividends (or distributions) by MSIG AG after that date would
have some form of risk-based solvency test via the internal group controls.
7.99. At the date of this Report the exact formulation of the risk-based capital adequacy test (referred to in
paragraph 7.97 above) in terms of its calculation, monitoring and enforcement has not been made and
therefore its effectiveness is unclear. Nonetheless, I am informed by the legal advisors to MSIEu (in relation
to the Scheme) that recognition and enforceability of judgments and orders within the EU is dealt with by the
Brussels Regulation (Council Regulation 44/2001, the “Regulation”). Under the Regulation, recognition of the
Court undertaking (for the risk-based capital adequacy test) would be automatic without any formalities being
required, and furthermore, the process for the application for a declaration of enforceability is considered
quite straightforward. I am further informed that the Court undertaking is clearly drafted and it is therefore
unlikely that the German Court would refuse to grant a declaration of enforceability.
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7.100. I therefore take comfort that the Court undertaking (for the risk-based capital adequacy test) will be
recognised as such in both the UK and German courts. However, as the effectiveness of the Court
undertaking is unclear (see paragraph 7.99 above) I will need to review the terms of the calculation,
monitoring and enforcement of the risk-based capital adequacy test prior to the sanction of the Scheme and
comment thereon in my update report (see paragraph 1.26 above).
7.101. The wording of the Court undertaking (for the risk-based capital adequacy test) is designed to prevent any
deliberate distributions, in circumstances where MSIG AG's Available Capital (eligible own funds in Solvency
II terminology) would as a result fall below 100% of proto-type Solvency II capital requirements (based on
the standard formula) in the period from the Effective Date to the earlier of the implementation of Solvency II
in Germany and 1 January 2019.
7.102. As proposed, the undertaking relies on MSIG AG not deliberately breaching the undertaking given to the
Court. I am informed by the legal advisors retained by MSIEu (in relation to the proposed Scheme) that any
such breach would be in contempt of Court, and could potentially lead to sanctions being imposed on MSIG
AG. As such in my view it is reasonable to assume that MSIG AG will not deliberately breach the
undertaking.
7.103. If, subsequent to the undertaking being given, MSIG AG's calculation of its eligible own funds (and the
impact on them of any proposed distribution) shows that either they are in any event, or will as a result of
any proposed distribution, fall below 100% of the proto-type Solvency II capital requirements calculated in
accordance with the undertaking, MSIG AG will not be able to make such a distribution, or will have to apply
to the Court to vary the undertaking, in order to avoid breaching it. I am informed by the legal advisors
retained by MSIEu (in relation to the proposed Scheme) that, if such an application were made, it is probable
the Court would seek confirmation from the BaFin (and possibly the PRA/FCA) that they had no objection to
the lower level of risk-based capital than that required by the undertaking and/or some evidence that it
should not prejudice policyholders before granting such an application.
7.104. If, subsequent to the undertaking being given, MSIG AG‟s calculation shows that eligible own funds are at
least 100% of the proto-type Solvency II capital requirements (calculated in accordance with the
undertaking) the undertaking is being complied with and, subject to it not causing a breach of the
undertaking, any proposed distribution can be made without any Court application being required.
7.105. In terms of the calculation underlying the undertaking, I am informed by the legal advisors retained by MSIEu
(in relation to the proposed Scheme) that MSIG AG has agreed to have the calculation reviewed by an
independent actuary with the necessary experience of non-life actuarial matters, who would be asked to
provide confirmation of whether the calculation and the assumptions contained therein were appropriate and
reasonable and carried out as envisaged, and hence whether MSIG AG was adhering, as per the Court
undertaking, to the formulation of the risk-based capital adequacy test.
7.106. The selection of a suitable independent actuary would be for MSIG AG to determine at the time, rather than
state a particular person (or firm) to undertake the role ahead of the time when such an assessment (if any)
was needed.
7.107. The undertaking means that the interests of the transferred MSIEu policyholders will not only be protected by
the adequacy of the initial level of capital (see paragraph 7.88 above), the on-going BaFin regulatory capital
requirements on an MCR (Solvency I) basis, the establishment of Equalisation Provisions (as per German
GAAP principles), and the MSIJ Credit Support Guarantee, but also by an on-going risk-based capital
underpin as described in paragraphs 7.97 to 7.105 above.
7.108. It is my view that the capital undertaking provides an understandable, practical and suitable means of
assessing, on a risk-based capital approach, the solvency capital requirement for MSIG AG when the
company is considering a distribution in the period between the Effective Date and the likely implementation
of Solvency II.
7.109. After the proposed transfer MSIG AG will remain a subsidiary of MS & AD. Therefore, as described in
paragraph 7.121 below, while there is no absolute certainty that MS & AD will be able to meet in full all
policyholders commitments, the existence of the parent constitutes additional (albeit non-enforceable)
comfort to all the policyholders of MSIG AG.
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Conclusion with regard to the post-Scheme Excess Assets of MSIG AG
7.110. I am satisfied that the level of financial security enjoyed by the policyholders of MSIEu transferring
under the Scheme, will not be adversely impacted to any material extent. Furthermore, the
policyholders of MSIEu transferring under the Scheme will enjoy the protection provided by the risk-
based capital undertaking.
RELATIVE SECURITY OF THE TRANSFERRING MSIEU POLICYHOLDERS PRE AND POST TRANSFER
7.111. As I have concluded above, the Transferring Policyholders currently enjoy the financial security of a well-
capitalised company as a result of the excess assets (Available Capital) of MSIEu, and will continue to do so
as policyholders of MSIG AG if the Scheme is sanctioned.
7.112. I also need to consider the position of the policyholders pre-transfer in the scenario of a failure of MSIEu
relative to that of the policyholders post-transfer in the scenario of a failure of MSIG AG. As described in
Section 2, the comparative position of policyholders in a winding-up situation in a UK or German insurer
depends on the assets available (and their size relative to the Technical Provisions) and the proportion of
inwards reinsurance business relative to direct business.
7.113. In the pre-transfer winding-up scenario the direct policyholders of MSIEu rank equally and above inwards
reinsurance policyholders and all other unsecured/non preferential creditors, i.e. direct policyholders would
get access to the available assets (after meeting the claims on assets subject to rights in rem and those of
certain other preferential creditors, e.g. employees) ahead of the inwards reinsurance policyholders of
MSIEu.
7.114. MSIG AG writes inwards reinsurance business. The volume of inwards reinsurance business written in 2012
was around 20% of the total business written, i.e. a large proportion.
7.115. It follows that in a winding up situation of MSIG AG post the implementation of the Scheme the policyholders
of MSIEu transferring to MSIG AG could be in a worse position if the available assets of MSIG AG are
insufficient to cover the Technical Provisions, since they would have to share these assets with the inwards
reinsurance policyholders of MSIG AG.
7.116. The position of the existing policyholders (including inwards reinsurance policyholders) of MSIG AG in a
winding-up situation is unchanged, save that there would be a greater level of Technical Provisions and
corresponding assets resulting from transfer under the proposed Scheme.
7.117. I do not believe that the winding-up scenario exposes the transferring policyholders of MSIEu or the existing
policyholders of MSIG AG to a materially increased risk for a number of reasons, including the two points
below:
The reserve strength and excess asset position of MSIG AG (as described above) makes the
likelihood of a winding-up scenario remote; and
The Credit Support Guarantees11
provided by MSIJ separately to MSIEu and MSIG AG means that
the affected policyholders should have claims settled via one of these guarantees in the event that
MSIEu or MSIG AG (as the case may be) is unable to do so.
11
Based on the information provided to me by the legal advisors to MSIEu (in relation to the Scheme) and the German lawyers I have retained in relation to the Scheme on the operation of the separate CSGs provided to MSIEu and MSIG AG by MSIJ, the different groups of policyholders affected by the Scheme should not be materially adversely impacted by the operation of the CSGs. Nonetheless, for the avoidance of doubt, I have been informed through MSIEu that the CSG between MSIG AG and MSIJ will be amended to specifically include the transferring policyholders of MSIEu. I will comment on the implementation of this matter in my supplemental report (see paragraph 1.26 above).
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7.118. As stated in paragraph 5.18 above, after the implementation of the Scheme, MSIG AG will not participate in
the FSCS. The impact of this is minimal because, as identified in paragraph 7.117 above, the winding-up
scenario is remote, and because of the existence of the Credit Support Guarantees provided by MSIJ. As
such a call on the statutory fund of the FSCS is likewise remote. Furthermore, the relevant Transferring
Business (essentially household) is a very small proportion (less than 0.1%) of overall premiums (with an
average premium of circa £300). Such business would be expected to run-off very quickly, i.e. the time
exposure for the eligible transferring policyholders of MSIEu to the loss of the benefit of the protection
afforded by the FSCS will be small (I would estimate no more than 24 months following the Effective Date). I
am therefore of the view that the loss of the protection afforded by the FSCS to the eligible transferring
policyholders of MSIEu will not materially adversely impact the financial security they enjoy post-Transfer.
7.119. Furthermore, once the proposed Scheme is implemented, all the policyholders of MSIG AG, including the
transferring policyholders of MSIEu, will be part of a growing, very well capitalised company (on a forecast
Solvency 1 basis as at 31 December 2013) focused on its existing and target customer base in continental
Europe (see paragraphs 5.1 and 7.88 above). Therefore, it is not unreasonable to take the view that the
benefit as envisaged by MS & AD to the whole group of transferring policyholders (i.e. being part of a
growing very well capitalised company focused on its existing and target customer base in continental
Europe) should outweigh the “negative” aspect of the loss of the FSCS protection in respect of the small
sub-group of policyholders within the whole group of transferring policyholders, particularly in light of my
observations in paragraph 7.118 above.
Overall Conclusion with Regards to Excess Assets
7.120. Overall, based on my analysis as set out above, I believe the Scheme will not adversely impact to
any material extent the security of the transferring policyholders of MSIEu.
The Change in Risk Exposure due to the Scheme
7.121. Prior to the proposed transfer MSIEu and MSIG AG are both ultimately subsidiaries of MS & AD, and remain
so post-transfer (albeit with their combined portfolios shared differently). It follows, therefore, that at a group
level there is no change in the overall risk.
7.122. The portfolio to be transferred under the proposed Scheme consists of the continental European branch
business of MSIEu. If the Scheme is sanctioned the Transferring Policyholders will become policyholders of
MSIG AG and no longer exposed to the insurance business written/assumed by MSIEu, including the run-off
classes, which contain US APH liabilities.
7.123. Although the transfer will expose the transferring business of MSIEu to the risks of the MSIG AG business,
these risks are presently relatively small. However, I note that:
The transferring business of MSIEu will have the safeguard of the risk-based capital adequacy test in
MSIG AG after the implementation of the Scheme until the introduction of Solvency II (or 2019 if
earlier);
The risks associated with the transferring business of MSIEu are currently understood and managed by
MSIEu and the knowledge and expertise associated with these risks will in the main transfer to MSIG
AG (including the continental European branches of MSIG AG) after the Scheme; and
While the liabilities in MSIG AG are expected to grow significantly as it writes future business, the
transferring business of MSIEu will benefit from the diversification of the portfolio as it grows, i.e. the
overall volatility of experience should decrease with a broader spread of risks. However, I note that the
growth in the business will impact on the regulatory capital requirements of the company, but as noted
in paragraph 7.52 above, MSIG AG will be the flagship risk carrier in continental Europe for MS & AD
and so there is unlikely to be any material dilution of its solvency due to its critical role in MS & AD. In
addition, MSIG AG is required to hold significantly higher Equalisation Provisions (that act as pseudo
capital) than would be the case for an equivalent UK insurer.
Conclusion
7.124. I am satisfied that the proposed Scheme will not materially change the risk exposures of the
transferring business of MSIEu.
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The Change in Policy Servicing due to the Scheme
7.125. I have held face-to-face discussions with the Management Board and the senior management of MSIG AG
regarding the structure and operation of the core functions (as listed in paragraph 7.126 below) within the
company. In addition, I attend the Joint Programme Board12
(“JPB”) meetings as an observer. Furthermore, I
have attended, as an observer Internal Audit Reviews (“IARs”) of each of the core functions, and a branch
monthly meeting (“BMM”) for the (internal) German branch. For the purposes of my review of the core
functions relating to Policy Servicing, I refer to my cumulative discussions and attendance (as an observer)
at the JPB, IAR and BMM as described above as my (non-financial) “Analysis”.
7.126. I have classified the various effects of the Scheme for those policyholders transferring to MSIG AG
according to the following core functional categories:
Corporate Governance, Compliance and Legal;
Branch management and oversight;
Information systems and infrastructure;
Finance, Actuarial and Investments;
Human resources;
MaRisk and other risk management issues;
Underwriting and Claims.
7.127. These functions have been subject to Internal Audit Reviews carried out in June 2013 (during which time I
observed the process over a two day period) and July 2013 by the Internal Audit function13
retained by MSIG
AG. The key objectives of the review were to provide assurance that the processes and procedures were
appropriately embedded for all the work-streams relating to the above functional categories.
7.128. The following paragraphs set-out the results of my (non-financial) Analysis (as at the date of this Report) for
each core function in turn.
Corporate Governance, Compliance and Legal
7.129. MSIEu has invested heavily over the last two years in building a robust governance system, and creating an
embedded governance culture as triggered by the needs emerging from the RP. It is therefore not
unreasonable to assume that the current corporate governance structure in MSIEu is fit-for-purpose.
7.130. MSIG AG intends to abide by the general principle that corporate governance systems, processes and
policies established by MSIEu during the RP will be retained within MSIG AG. To examine this intention, I
have reviewed a document (together with supporting material) prepared by MSIG AG that provides a
comparison (mapping) of the corporate governance structure in MSIG AG with the restructured governance
and committee structure in MSIEu (see paragraph 3.30 above).
7.131. Based on my review, I believe this comparative analysis demonstrates that the corporate governance
structure in MSIG AG compares favourably (although not always directly due to German legal and regulatory
practices) with that of MSIEu, that is to say that there are no corporate governance functions or activities in
MSIEu that are not present in MSIG AG (and vice versa). In particular, I set-out below those Corporate
Governance functions I believe compare (broadly) favourably and which functions are (broadly) equivalent
between MSIG AG and MSIEu:
12
The JPB is a group of senior managers/personnel from MSIEu and MSIG AG that manages issues pertaining to the proposed Transfer.
13 The Internal Audit Charter, Guideline and Plan for MSIG AG during 2013 have been prepared. The outsourcing agreement has been approved by
BaFin, and the work-stream is fully embedded. A Service Level Agreement with MSIGHE for additional internal audit support has been agreed and signed.
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The duties of the Executive committee of MSIEu include development of strategy, monitoring
performance, risk assessment & control, and prioritisation and allocation of resources. All of these
duties are similarly performed by the Management Board of MSIG AG. I am therefore of the view
that the governance of this function compares favourably between MSIEu and MSIG AG;
The Underwriting & Claims committee of MSIEu has as its counterpart in MSIG AG the (monthly)
line of business meetings (covering underwriting, claims and service & support) and the (fortnightly)
Chief Underwriting Officer (CUO) meetings. The CUO is a member of the Management Board and
therefore matters arising from such meetings are, as necessary, directly escalated up to the
Management Board. I am therefore of the view that the governance of this function is broadly
equivalent between MSIEu and MSIG AG;
The Finance committee of MSIEu has as its counterpart in MSIG AG the Finance meetings run by
the Chief Financial Officer (CFO) who is a member of the Management Board. The financial topics
discussed include reporting, management, and capital (i.e. similar to those of the Finance
Committee of MSIEu). The output from these meetings are notes prepared by the CFO for the
Management Board (e.g. monthly management accounts, financial forecasts and budgets, and
financial risk management updates). Further, all finance related matters which need Management
Board approval are taken by the CFO to the Management Board. As such, no decision making
takes place in the Finance meeting and the main purpose of the meeting is to advise and assist the
Management Board on finance matters. I am therefore of the view that the governance of this
function is broadly equivalent between MSIEu and MSIG AG;
The Reserving committee of MSIEu has as its counterpart in MSIG AG the Reserving meetings run
by the CFO. The topic of the meeting is reserving matters as they impact the company (i.e. similar
to that of the Reserving committee of MSIEu). In terms of Management Board direction/oversight,
the outcome(s) of the Reserving meeting are immediately escalated to the Management Board for
approval/conclusion. I am therefore of the view that the governance of this function is broadly
equivalent between MSIEu and MSIG AG;
The duties of the Risk & Capital committee of MSIEu falls under the ultimate and non-delegable
responsibility of the Management Board of MSIG AG (as per MaRisk, clause 7.2.1.3b). I am
therefore of the view that the governance of this function compares favourably between MSIEu and
MSIG AG;
Reinsurance is currently managed on a joint basis, and as such MSIG AG contributes directly to the
MSIEu reinsurance committee. I am therefore of the view that the goverence of this function is
effectively equivalent between the two companies;
The function of the Audit committee within MSIEu falls within the terms of reference of the
Management Board of MSIG AG. Furthermore, the Supervisory Board of MSIG AG has
responsibility for the appointment and control of the Audit function. I am therefore of the view that
the governance of this function compares favourably between MSIEu and MSIG AG;
The function of the Remuneration & Nomination committee within MSIEu falls within the terms of
reference of the Management Board of MSIG AG. Furthermore, the Supervisory Board of MSIG AG
must give its approval if additional staffing would exceed the recruitment budget. I am therefore of
the view that the governance of this function compares favourably between MSIEu and MSIG AG.
7.132. In addition to my review of the comparative analysis (as outlined above), as part of my (non-financial)
Analysis, I have confirmed that (at the date of this Report) evidence of the embedding of various corporate
governance functions within MSIG AG exists and has been provided to Internal Audit for testing as set out
below:
the Management structure, roles and accountabilities have been documented and implemented,
including: the appropriate documentation of Management Board and Supervisory Board meetings,
and their establishment with members containing the appropriate mix of skills and experience (as
approved by BaFin);
The Panel (committee) structures for the Investment and Information Technology committees have
been established with clear authorities and accountabilities;
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Finance and Reserving meetings are run under the auspices of the Chief Financial Officer (who is a
member of the Management Board). As such any finance and reserving matters arising from such
meetings are, as necessary, directly escalated up to the Management Board. Nonetheless, I am
informed by MSIG AG that it is planning to introduce a more structured approach to finance (and
reserving) meetings, in terms of attendees, formal agenda, and minutes, to be implemented within
the 4th quarter of 2013, after the new head of finance joins the company as of 1
st October 2013;
Management information as required by the Management and/or Supervisory Boards have been
agreed and approved;
A list of 3rd
party contracts has been established and embedded;
The outsourcing procedures have been established and embedded;
Compliance policies, reporting (including dashboards), training and practice have been established
and embedded;
Legal policies (relating to compliance, e.g. conflicts of interest, money laundering, bribery, etc.)
have been established and embedded.
7.133. The IARs concluded that the work-stream is fully embedded, although it has not been completely tested by
Internal Audit.
7.134. As mentioned in paragraph 7.125 above, I have met face-to-face (on several occasions including on site in
Cologne where the head office of MSIG AG is located) with the senior management of MSIG AG, including
the Management Board members. In these meetings I have discussed roles, responsibilities (including
membership of the Management Board and/or committees/panels as appropriate), management information,
procedures, controls and contribution to risk management. This in part also contributed to my (non-financial)
Analysis.
7.135. Based on my (non-financial) Analysis, I am satisfied that the structure and operation of corporate
governance, compliance and legal in MSIG AG is reasonable.
Branch Management and Oversight
7.136. The branch management and oversight framework established in MSIEu during the RP has been
independently reviewed and embedded within MSIEu, and has provided an effective way of monitoring
MSIEu‟s branches prior to the transfer. This framework has essentially been embedded within MSIG AG,
including Underwriting, Finance and Claim Control Points (“CP-U”, “CP-F” and “CP-C” respectively), Branch
Monthly Meetings (“BMMs”) and Branch Managers Forums (“BMFs”). The rest of this sub-section describes
the way in which these processes have been adopted by MSIG AG.
7.137. The branch oversight system‟s effectiveness is highly dependent on the level of engagement from senior
management. Following the transfer to MSIG AG, there needs to be sufficient representation from senior
management at both the BMM and BMF, and meaningful challenge of function holders within those
meetings, for the branch oversight system to work effectively. I note that the MSIG AG Internal Audit function
has reviewed the branch management and oversight framework for the Slovakian branch and the BMM
process for the (internal) German branch and no issues arose. In addition, members of MSIG AG‟s
management team have attended MSIEu‟s BMF and are familiar with the system in practice across MSIEu‟s
multiple branch network.
7.138. Control Points (“CPs”) are monitored via BMM on a red/amber/green (“RAG”) basis. A CP at amber or red
status triggers escalation to the relevant risk owner, who in turn may escalate the issue to the Management
Board. The CPs in place are CP-C for claims, CP-U for underwriting and CP-F for finance. These CP
categories have been implemented (and satisfactorily tested by Internal Audit) within MSIG AG as follows:
Claim handling and CP-C: The philosophy for establishing case reserves on individual claims will
remain unchanged following the transfer. This philosophy is to establish realistic but cautious claim
reserves, where cautious means that each case reserve should take into account known factors that
could adversely impact the final outcome for each claim. The claim handling CP require all individual
case reserves to be reviewed at least quarterly or whenever new information on a claim is received
(whichever is the more frequent). The claim reserving policy is subject to review at least annually and,
in any case, whenever there is a relevant legislative change.
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Underwriting (including reinsurance) and CP-U: The underwriting CP monitor significant changes
in both gross and ceded accounts including premium, commissions, policy limits and policy terms and
conditions (such as territorial scope). These CP ensure that total exposures are monitored and
important account changes understood. In addition, the appropriateness and security of outwards
reinsurers is managed using the CP-U controls.
Finance & credit control (including actuarial) and CP-F: The finance controls validate the financial
records including cash balances and third party debtors (brokers, policyholders, reinsurers or other
third parties). While not part of CP-F, I have discussed the process for calculating the IBNR reserve
and understand that, while there will be changes to reflect German statutory requirements, the general
approach will not change, whereby a detailed parameter review will take place at least annually. MSIG
AG will continue to commission an independent external review of reserves.
7.139. BMMs are currently in place for MSIG AG within the (internal) German branch and the Slovakian branch
and has been implemented within the French branch of MSIEu to be rolled over to the French branch of
MSIG AG with effect from 1 July 2013 (the commencement/operational date for French branch of MSIG AG).
MSIG AG‟s Internal Audit function has reviewed the effectiveness of the BMM process for the Slovakian
branch and (as part of the roll-over process) for the French branch, and in each case considered it
satisfactory. These reviews have concluded that this critical part of the branch oversight process has been
successfully embedded within these branches. All other MSIG AG branches (Belgium, the Netherlands,
Spain and Italy) will be established during the second half of 2013 and incorporated into the branch oversight
process as they gain their respective licences, and commence operation on and after the Effective Date.
7.140. Furthermore, I attended (as an observer) a BMM for the (internal) German branch to evidence the content
and running of the meeting. Based on my attendance, I obtained the following evidence:
The agenda was relevant and included the following items: KPIs, control points, review points, the
status of Internal Audit matters and underwriting reporting;
The control points (and dashboards) for underwriting, claims and finance were discussed and items
resolved (or deferred if appropriate); and
There was challenge from senior representation from Head Office management (including two
members of the Management Board).
7.141. In addition to the BMMs, there are quarterly BMFs. These provide an opportunity for dissemination of
strategic information to branch managers across MSIG AG‟s branch network. The BMF Framework has
been approved by the Management Board of MSIG AG and satisfactorily reviewed by Internal Audit.
7.142. The IARs concluded that the branch oversight work-stream is fully embedded and has been completely
tested by Internal Audit. Additionally, an audit of the Slovakian and (internal) German BMM processes has
been conducted and Internal Audit attended the BMMs of both branches.
7.143. Based on my (non-financial) Analysis, I am satisfied that the structure and operation of branch management
and oversight in MSIG AG is reasonable and will operate with an equivalent level of discipline to that already
established within the MSIEu.
Information Systems and Infrastructure
7.144. The information systems and infrastructure for MSIG AG at the date of this Report is summarised below:
Apart from the exceptions noted below, the transactional systems used by branches to process policy
and claim information will remain unchanged after the transfer.
All branches of MSIG AG post-Transfer, like those of MSIEu pre-Transfer, will continue to use Oracle
as its General Ledger (“GL”) platform, although MSIG AG uses a later (more recent) version of Oracle
than MSIEu. I understand this should not have a major impact because Oracle is “downwardly
compatible”, meaning that information compatible with earlier Oracle system versions remains
compatible with newer system versions.
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The “template” reporting system established by MSIEu (which has been in place for a number of
years, as the predecessor to the PAS underwriting system) continues to be used by those branches in
which PAS was not implemented. This system has been replicated within MSIG AG for the purpose of
uploading monthly branch data to the GL (Oracle). The main change from the template process in
MSIEu is the use of a slightly different configuration for mapping data from the template to Oracle,
given that MSIG AG has a slightly amended chart of account infrastructure. There is no change to the
way that data is entered into the template by individual branches.
The template system is already in place for the Slovakian branch and has been adopted in the French
branch (with effect from 1 July 2013). MSIG AG‟s Internal Audit function has reviewed and tested the
template process in the Slovakian branch and concluded that it is working effectively. This should
ensure that the revised interface between the template and Oracle is working as expected. In
particular, I have drawn the following conclusions:
o MSIG AG‟s template process for the Slovakian branch has been tested by Internal Audit and remained essentially the same as that used by MSIEu;
o The templates are populated by the same staff in the same functions using the same procedures for both companies, as MSIEu staff have (in large part) already transferred or will be transferred following completion of the proposed Scheme;
o The data input from the templates into Oracle (financial ledger system) at Head Office in Cologne has been tested for the (internal) German and Slovakian branches. As evidenced in the report prepared by Internal Audit it was comfortable with the testing and the outcomes. As the same templates will be used for the other branches of MSIG AG in the future there is no reason to believe that the template process would not work as for the other branches in MSIEu.
I am therefore satisfied that the template process in MSIG AG will operate with an equivalent level of
discipline to that already established within the MSIEu branches.
I have been provided by MSIG AG with a comparative analysis showing the administration (and
financial ledger) systems to be used by the branches of MSIG AG post-Transfer with those used by
the branches of MSIEu pre-Transfer. Based on my review of this comparative analysis, with the
exceptions of the (internal) German and French branches, the policy administration software platforms
used by the branches of MSIG AG post-Transfer will be the same as those used by the corresponding
branches of MSIEu pre-Transfer (and run by the same branch staff since they will move on a one-for-
one basis from the old MSIEu branch to the corresponding new MSIG AG branch in accordance with
the BTA).
MSIG AG‟s information systems will be supported using an outsourced model that relies on third
parties to provide system infrastructure and networking facilities to MSIG AG. This model is not
dissimilar to the information system model currently employed by MSIEu. The main difference being
that MSIEu currently undertakes development work in-house on PAS, which will not be required by
MSIG AG as it uses Tainas (for which development work will be out-sourced to the software provider).
The remainder of this sub-section notes the particularities around the data processing in the French
and (internal) German branches. These are anticipated to be the two largest branches of MSIG AG.
The transactional system used within MSIEu‟s French branch, “Marsys”, will be adopted by MSIG AG,
which will begin processing new business onto a copy of Marsys from July 2013. It is intended to
combine the transferring policyholders and the receiving policyholders onto one copy of the Marsys
system at the time of the Transfer. This process will be managed by the vendor of Marsys. I am
informed that Marsys employs a system of unique policy identifiers, which should minimise the risk of
any policy duplication during this merging process. In essence, the French branch of MSIG AG will
take a copy of Marsys operating in the French branch of MSIEu onto which new (and renewed)
business during 2013 will be entered. Furthermore, as at the time of the transfer, there will only be a
small number of 2013 policies and claims processed onto MSIG AG‟s version of the Marsys system,
manual migration of these policies constitutes, in my view, a reasonable contingency plan.
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The transactional system used within the (internal) German branch of MSIG AG differs from that used
currently within the German branch of MSIEu. Since MSIG AG‟s creation in 2012, all new policies
have been processed onto the “Tainas” system, an AS/400 system supported by IBM. Tainas is an
abbreviation of “Taisho Marine INAS”. The licence owner for the INAS system is UNIQA Software
Service GmbH Wien and INAS is used by several other insurers and brokers within the German
market for policy servicing. Tainas was used in the MSIEu German branch prior to 2010, before the
implementation of PAS.
I understand Tainas is preferred by MSIG AG over PAS since it more readily meets German reporting
requirements, and is considered to provide superior functionality, particularly in respect of cash
matching, and other financial controls.
In 2012, MSIG AG commissioned external consultants to perform a review of the Tainas system and
the way in which it had been implemented within MSIG AG. This report identified several deficiencies
with the original implementation of Tainas, including the extent of data security and control. Therefore,
a further independent review by different external consultants was commissioned by MSIG AG to
analyse the company‟s plan to address these deficiencies (which I have received a copy of), and
confirms that MSIG AG has identified solutions to the original deficiencies identified, and that these
solutions have been implemented.
I comment separately below on the implications of MSIG AG‟s data transfer plan for the transferring
policyholders within the German branch of MSIEu.
7.145. The IARs concluded that the necessary documentation has been provided, the template process is working
effectively, and the work-stream is embedded. It also noted that some minor service agreements are still to
be evidenced, and that, with the exception of the Data Transfer plan (see below), testing of the other
processes has not yet been undertaken.
7.146. Notwithstanding the minor exceptions noted above, and based on my (non-financial) Analysis, I am satisfied
that the structure and operation of information systems and infrastructure is reasonable.
Data Transfer from PAS to Tainas
7.147. MSIG AG intends to transfer policies onto Tainas on a manual basis. From 1 January 2014, the following
movements will trigger the manual transfer of a policy onto Tainas:
A policy is renewed; or
There is a mid-term adjustment (such as an endorsement) on a policy; or
There is a claim movement on a policy (either a claim payment or a case reserve review).
7.148. A copy of all pre-transfer policyholder data will be preserved by MSIG AG on a static version of PAS,
although it will still be possible to run management reports from this static copy of PAS. The version of PAS
preserved in MSIG AG will not, however, interface with MSIG AG‟s General Ledger (Oracle). All open
transactions within PAS will therefore need to be uploaded onto Tainas during the first quarter of 2014 in
order to derive financial statements from 31 March 2014.
7.149. This proposed transfer process means that certain financial data will need to be sourced from both PAS and
Tainas. Examples of such data are claim development triangles for reserve analyses, information needed to
process outwards reinsurance and earned premium values in respect of in-force policies.
7.150. While sourcing data from two systems brings the risk of either omission or duplication of data, MSIG AG is
designing controls around the data to ensure that this risk is minimised. These controls (as well as the whole
Data Transfer project) are subject to continuous review by Internal Audit.
7.151. The availability of a preserved (pre-transfer) copy of the PAS data within MSIG AG should ensure that no
data is lost or corrupted as a result of the transfer of policies to Tainas. This should assist in ensuring that
policyholder service levels in respect of transferring policyholders are maintained.
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7.152. I have reviewed the Data Transfer project plan and am satisfied that it represents a reasonable process by
which the relevant data presently held on PAS can be transferred to Tainas such that policyholder service
levels in respect of transferring MSIEu policyholders are not materially adversely affected on or after the
Effective Date.
7.153. The IARs confirmed that Internal Audit is continually reviewing the Data Transfer project. Furthermore,
based on its review of the plan, the timeframe appears realistic and that the plan can be delivered in time
(within budget).
7.154. Based on my (non-financial) Analysis, I am satisfied that the status of the Data Transfer project is
reasonable.
Human Resources
7.155. The status of Human Resources within MSIG AG at the date of this Report is summarised below:
MSIG AG has transferred several staff who previously worked within the German branch of MSIEu to
support the new head office functions of MSIG AG. This has led to corresponding vacancies within the
(internal) German branch of MSIG AG and certain individuals are in the process of being recruited. To
the extent that these positions remain vacant, there is the risk of insufficient staff resource to manage
the German business internally or insufficient attention to head office functions from head office
resources whose time might be taken up with the management of German (internal) branch issues.
At the date of this Report, MSIG AG has filled the key positions relative to its head office staffing plan
(while noting that the start date of the recruited individuals is typically after 1 July, but on or before 1
October). Furthermore, in overall terms the comparative staffing levels of MSIEu (pre-Transfer) and
MSIG AG are broadly equivalent (the main exception being Information Services, where MSIEu
undertakes development of PAS, and no such development work will be undertaken by MSIG AG of
Tainas).
MSIG AG partially outsources several important control functions, including actuarial and internal
audit. This model brings the risk that certain critical individuals may have limited time available to
commit to MSIG AG matters whenever they may be conflicted by competing roles and responsibilities
outside MSIG AG. I am informed that additional internal audit support will be provided by the internal
audit function of MSIGHE after the Transfer (and at the date of this Report I understand that a service
level agreement has been agreed and signed). In addition, there is an actuarial resource within MSIG
AG available to support the external actuary retained by the company (see paragraph 7.164 below for
further details on actuarial resources).
7.156. The IARs confirmed that the Human Resources work-stream is embedded. Furthermore, Internal Audit‟s
testing of MSIG AG‟s organisational chart; job profiles; the recruitment and induction policy; and the
succession plan have been completed at the date of this Report.
7.157. Based on my (non-financial) Analysis, and notwithstanding the Human Resources items that remain to be
tested, I am satisfied that the structure and operation of Human Resources is reasonable.
MaRisk VA and Other Risk Management Issues
7.158. The risk management status of MSIG AG at the date of this Report is described below:
Responsibility for risk management rests with MSIG AG‟s Management Board. Under German law,
the Management Board is not permitted to delegate its risk management responsibilities to any
committees or sub-committees. MSIG AG does not intend, therefore, to establish a risk committee,
although MSIG AG has appointed a risk officer who is responsible for monitoring risks of all type and
reporting these to the Management Board. In addition, a member of the Management Board has been
identified as Risk Sponsor.
BaFin has laid out a risk management system within the German regulatory environment called
“MaRisk VA”. MSIG AG follows BaFin guidance on this subject to ensure the company‟s risk
management structure meets MaRisk VA requirements.
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MSIG AG‟s implementation of MaRisk requirements is constructed around a “three lines of defence”
governance model. This model is common market practice and has been structured by MSIG AG to
ensure a sufficient level of independent oversight and challenge of the various risks faced by the
company. The model reflects that adopted by MSIEu during the RP.
The following elements of MSIG AG‟s risk management framework have been implemented: a risk
management framework, risk register and risk appetite statements. I have reviewed the relevant
documents and believe them to be a reasonable replication of the relevant parts of the risk
management system in place within MSIEu.
MSIG AG‟s risk management framework identifies level 0, level 1 and level 2 risk appetites. Level 0
requires referral to MSIJ, level 1 requires referral to the Management Board and level 2 requires
referral to senior management within MSIG AG. The risk tier is determined from consideration of the
risk register in conjunction with the metrics contained within MSIG AG‟s risk dashboard.
Both MSIG AG and MSIEu are required to meet the requirements of the “management handbook”
issued annually by MSIJ. This stipulates particular occasions where permission for certain types of
corporate action must be sought from MSIJ (for example, in relation to proposed acquisitions or
changes to the business structure or strategy). MSIG AG has confirmed to me that the requirements
of its management handbook are not materially different from those issued to MSIEu.
A further level of scrutiny is provided by the requirements of Japan‟s Financial Instruments and
Exchange Act 2008 (“J-SOX”). This law provided for a level of internal controls across listed
companies in Japan and IT controls, in particular, are an important focus of J-SOX. MS & AD‟s listing
in Japan means that important subsidiaries (as defined by MSIJ) are subject to J-SOX requirements.
Prior to the Transfer, MSIEu has been subject to J-SOX requirements; following the transfer MSIG AG
will become subject to J-SOX requirements. I am informed that the combination of risk policies and
procedures being created in order to meet BaFin requirements will be sufficient to meet J-SOX
requirements.
7.159. The IARs concluded that this work-stream is fully embedded and has been completely tested by Internal
Audit. Internal Audit will conduct its annual audit of the Risk Management System including compliance with
legal and regulatory requirements (VAG, MaRisk VA) later during 2013.
7.160. Based on my (non-financial) Analysis, I am satisfied that the structure and operation of Risk Management
(MaRisk VA) is reasonable.
Finance, Actuarial and Investments
7.161. At the date of this Report, the Finance department undertakes the day-to-day management of finance,
actuarial and investments. The key areas of activity include:
Capital management;
Financial controls;
Financial statements and records;
Documentation of the core financial processes;
Actuarial function (and responsibilities) including reserving;
Investments, including guidelines, procedures and risk management.
7.162. Within the Finance department (excluding Actuarial and Investments) many of the documents for this area
have been written, evidenced and tested by Internal Audit and as such are considered to be embedded.
Additionally, as mentioned above, Internal Audit has performed a review of the Slovakian template process.
7.163. A senior finance person has been recruited and will start in October 2013. This together with the Part VII
advisory support being provided by external accountants is anticipated to provide sufficient resources for the
Finance area to effectively deal with all the relevant finance matters of MSIG AG up to the Effective Date.
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7.164. Within the Actuarial area the roles and responsibilities have been defined, the guidelines of the actuarial
function (including reserving) have been implemented and the annual reserving report as of 31 December
2012 has been prepared. An actuary has been recruited and will start in October 2013. In the meantime, the
external actuary presently retained to provide senior actuarial support will continue to be used.
7.165. The terms of reference for the Investment Committee and the Investment Guidelines have been
implemented and tested by Internal Audit. Internal Audit is a permanent attendee (without voting rights) of
the Investment Committee. The work-stream is therefore deemed to be fully embedded, while noting that
further work is required in anticipation of future funds. In addition, Internal Audit testing of Investment Risk
Guidelines, Investment Procedures Manual and Treasury Procedures Manual has not yet been undertaken.
7.166. The IARs concluded that while the Finance department has embedded many of the key processes it requires
additional resources in order to effectively deal with all the relevant finance matters of MSIG AG (including
the Transfer) up to the Effective Date. In order to deal with the work demands on the Finance department,
MSIG AG has recruited a senior finance person (starting in October 2013), commissioned external
accountants to provide advisory services (including resources), and has recruited an actuary (as described
in paragraph 7.164 above).
7.167. While noting the resource requirements described above, based on my (non-financial) Analysis I am
satisfied that the structure and operation of the Finance department is not unreasonable.
Underwriting and Claims
7.168. At the date of this Report:
Policy documents in relation to Underwriting oversight, Exposure Management, Aggregation,
Accumulation processes and Reinsurance have been written, approved (by the Management
Board) and tested (by Internal Audit);
The Underwriting and Reinsurance technical file review manual (based on the MSIEu process) has
been documented and tested (by Internal Audit). Technical file reviews have also been undertaken
for the Slovakian branch and Liability business written by the (internal) German branch with in each
case no matters arising;
Policy documents in relation to claims handling, claims reserving, claims authority limits and
reporting, large loss reporting and the claims administration process have, in the main, been rolled-
over from those used by MSIEu and approved (by the Management Board). However, some items
remain to be tested by Internal Audit;
Technical file reviews for Claims have been undertaken for the Slovakian branch and the (internal)
German branch with in each case no matters arising.
7.169. The IARs concluded that the Claims work-stream is fully embedded and only some minor items remain to be
tested by Internal Audit. On the basis that staffing, processes and reporting have not changed significantly
from MSIEu policies, authority limits and reporting, they have been rolled over to MSIG AG. In addition,
Claim technical file reviews were conducted in 2013 both in Slovakia and in Germany.
7.170. The IARs concluded that the Underwriting work-stream is fully embedded and has been completely tested by
Internal Audit. Internal Audit also conducted an intense audit of the underwriting of German Casualty &
Specialty (Liability) lines earlier in 2013. In addition, an Underwriting technical file review has been
conducted in Slovakia.
7.171. Based on my (non-financial) Analysis, I am satisfied that the structure and operation of Underwriting and
Claims is reasonable.
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Fair Treatment of Customers (“TCF”)
7.172. I have looked at the six outcomes that the FCA expects firms to achieve as part of TCF (see paragraph 2.26
above) and applied my understanding of TCF to MSIG AG as set out below:
Outcome 1 – the company pledges to follow the MS & AD charter of professional conduct, which
includes a responsibility to customers undertaking. In addition, most of the staff of MSIG AG have
received TCF training over the last 12 months as part of the MSIEu TCF training programme. A
refresher training programme (on the basis of the German TCF approach) is planned by the Legal
& Compliance Department for the 4th
quarter of 2013. Furthermore, compliance is a standing item
on the agenda for branch monthly meetings;
Outcome 2 – while MSIG AG does not have many retail customers, the products that are made available are targeted at a particular customer base, namely Japanese employees of major MS & AD clients. Furthermore, given MSIG AG‟s proposed voluntary participation to FOS, the eligible transferring policyholders of MSIEu will not be affected in their ability to bring complaints to FOS as a result of the Transfer;
Outcome 3 – by and large the MSIG AG business is broker led. The brokers are checked by the company, in particular the entry of a broker in the insurance intermediary register as proof that the supervisory authority for insurance intermediaries has already assessed the broker concerned and found them to be competent, financially stable, of good repute and reliable. If there is no entry for the broker concerned in the register, MSIG AG will not use that broker;
Outcome 4 – the majority of advice is given by brokers to commercial customers, and otherwise, on a non-advised basis to the employees of MSIG AG‟s customers;
Outcome 5 – at the date of this Report, there have been no complaints received by MSIG AG, and while the company has only been operating since the last quarter of 2012, this is indicative that the products and services are of an acceptable standard;
Outcome 6 – MSIG AG has a formal complaints handling policy for dealing with “any expression of
dissatisfaction by or on behalf of a client or any other person related to the insurance contract,
about any act or omission by us in connection with our financial services” (i.e. the definition used by
EIOPA for complaints). Therefore, subject to the relatively short history of the company, as claims
have been settled and mid-term adjustments processed without any complaints being received, this
is indicative that there are no unreasonable post-sales barriers imposed by the company on
customers. In addition, where a policy is cancelled the decision is accepted without any resistance
(on the assumption that the client has made this decision on a reasonable basis). Nonetheless, the
company investigates the reasons for a cancellation in order to find out if there is a need for
improvement on its side. The broker also gets immediate confirmation regarding the cancellation,
and the cancellation is entered into the company‟s IT-system.
7.173. Based on my review as described above, I am satisfied that TCF is satisfactorily embedded across MSIG
AG.
Limitation on Review of Change in Policy Servicing due to the Scheme
7.174. It should be noted that for all the systems, processes and policies outlined above, my views are based on
the assumption that they will operate as intended (now and in the future). While I have no grounds for
believing they will not do so, I cannot provide any guarantee that this will be the case. Fundamental to the
satisfactory on-going operation of the above systems, processes and policies is the Internal Audit function
and the tests it performs to ensure they operate as intended.
7.175. Nonetheless, I will update my (non-financial) Analysis as part of my supplementary report (see paragraph
1.26 above).
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Conclusion
7.176. I believe that, provided the proposed systems, processes and policies operate as intended, and I
have no grounds for believing they will not do so, the proposed Scheme will not have a materially
adverse effect on the policy servicing levels enjoyed by the transferring policyholders of MSIEu
compared to both their current position and their projected position at the Effective Date.
Conclusion for the Policyholders of MSIEu transferring under the Scheme
7.177. I am satisfied that the proposed Scheme does not affect in a materially adverse way either the
security or the policy servicing levels of the policyholders of MSIEu transferring under the proposed
Scheme.
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8. THE IMPACT OF THE SCHEME ON THE REMAINING POLICYHOLDERS OF
MSIEU
Introduction
8.1. If the Scheme is sanctioned the liabilities pertaining to the continental European branch business being
transferred to MSIG AG will be removed from the balance sheet of MSIEu, along with all assets related to
the business (including the associated reinsurance assets).
The Change in Financial Strength due to the Scheme
8.2. MSIEu‟s gross and net Technical Provisions (excluding Equalisation Provisions) will reduce by around 55%
and 61% respectively (broadly similar reduction percentages apply in respect of overall gross and net
liabilities) as a result of the proposed Scheme. However, the reserving basis adopted by MSIEu will not
change as a result of the Scheme and as such the remaining policyholders of MSIEu will continue to enjoy
the same level of reserve strength post the Scheme.
8.3. MSIEu‟s capital requirements on an MCR, ECR and ICA basis will reduce as a result of the removal of the
transferring liabilities and related risks from MSIEu‟s balance sheet under the proposed Scheme, while
Available Capital will not be changed (i.e. not proportionately reduced) other than from the results of carrying
on business in the normal way in the period up to the Effective Date. Therefore, the security of MSIEu
policyholders not transferring under the Scheme would be expected to improve as a result of the Scheme.
8.4. The remaining policyholders will also benefit from no longer having any exposure to the risks associated with
the liabilities of the continental European branch business being transferred to MSIG AG.
Conclusion
8.5. I believe that the proposed Scheme will not have a materially adverse effect on the security of MSIEu
policyholders not transferring under the Scheme compared to both their current position and their
projected position at the Effective Date.
The Change in Policy Servicing due to the Scheme
8.6. After the transfer, MSIEu will undergo a significant transformation (as set out in its Strategy and Business
Plan 2014 – 2018). The transformed entity will be designed to reflect the smaller volume of business to be
written within MSIEu after the Effective Date. In particular, only the UK business of MSIEu will remain open
and the Qatar branch will be closed. I have discussed the post-transfer transition plan with MSIEu.
8.7. It is intended that all relevant controls established during the RP will be retained by MSIEu. In general this
means retention of systems and controls relating to corporate governance except for branch oversight (given
the elimination of most of MSIEu‟s branches following the transfer).
8.8. While MSIEu‟s current IT system (PAS) will be used to manage the policies remaining with MSIEu up to the
Effective Date, I understand there is a plan to migrate the policies remaining in MSIEu to a new IT platform
following the Transfer, although no definitive decisions in relation to this proposed operational change have
been made within MSIEu as at the date of this Report. I am informed that this operational change is part of a
wider planned systems update in MSILM and MSIEu, with MSIEu migrating later than MSILM. The fact that
MSIEu will not be migrating in isolation (separately from MSILM) should ensure a high level of management
attention and control around any proposed migration plan.
8.9. In the period from 1 July 2013 up to the Effective Date, there will be changes to key personnel at MSIEu,
including the chief executive officer, the chief financial officer and the compliance officer. These personnel
changes introduce a risk that business knowledge relating to policy servicing is lost. I have, however,
compared the organisation chart from before the transfer with that following the transfer, including details of
relevant industry experience of key individuals. The proposed individuals taking up the most important roles
from 1 July 2013 up to the Effective Date have all had prior experience within MSIEu, including experience of
the RP, and have extensive prior experience within the insurance industry.
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8.10. MSIEu is in the process of revising succession plans to reflect the new function holders following execution
of the transition plan. I am informed that some of these succession plans will focus on the preferred profile of
an appropriate successor, without necessarily specifying an individual.
8.11. Many of the current (pre-transfer) incumbents of key positions at MSIEu will be dedicating more of their time
to MSILM. This somewhat mitigates the risk to MSIEu of losing key individuals because relevant business
knowledge and understanding will still be accessible through MSILM.
8.12. It is intended that some processes will be outsourced to third parties, including risk management, actuarial,
human resources and legal (general counsel) functions. The third parties will either be entirely external to
MSIEu, or might be individuals from within MSILM. I understand that service level agreements will be
established.
8.13. MSIEu‟s committee control structure will remain largely intact following the transfer. In particular, the Risk
and Capital committee and the Audit committee will remain in place.
8.14. I have discussed this transition plan with the company‟s senior management and am comfortable that the
plan should not compromise the significant risk management improvements achieved during the RP, and I
have also received confirmation from MSIGHE‟s internal audit function that no corporate governance
processes will be compromised as a consequence of the proposed transition plan.
8.15. There is an FCA requirement that companies treat customers fairly, and these requirements will apply to
relevant policyholders before and after the proposed transfer (while noting that the full TCF guidance on how
firms should comply with the Principles for Business applies only in the context of retail customers).
Conclusion
8.16. I believe that provided the proposed “down-sizing” of the administration functions of MSIEu is
implemented as intended, and I have no grounds for believing they will not do so, the proposed
Scheme will not have a materially adverse effect on the policy servicing levels enjoyed by the
remaining policyholders of MSIEu compared to both their current position and their projected
position at the Effective Date.
Conclusion for the Policyholders of MSIEu not transferring under the Scheme
8.17. I am satisfied that the proposed Scheme does not affect in a materially adverse way either the
security or the policy servicing levels of the policyholders of MSIEu not transferring under the
proposed Scheme.
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9. THE IMPACT OF THE SCHEME ON THE CURRENT MSIG AG
POLICYHOLDERS
Introduction
9.1. Under the Scheme, the MSIG AG policies will remain in MSIG AG in the same position as prior to the
Effective Date of the Scheme. The main effect of the Scheme on these MSIG AG policyholders arises from
the transfer into MSIG AG of the continental European branch business currently in MSIEu.
9.2. The key issues affecting existing MSIG AG policyholders as a result of the Scheme arise from changes in:-
The financial strength of MSIG AG as a result of the transfer in of some of the business from MSIEu;
The change in the risk exposures in MSIG AG;
The impact on policy servicing levels of the business of MSIG AG.
9.3. In this section I deal with each of these in turn.
The Change in Financial Strength due to the Scheme
9.4. In Section 7, I considered the current reserve strength of MSIG AG. Based on my review of the reserve
strength of MSIG AG, I concluded that MSIG AG is currently reasonably reserved and should continue to be
so after the implementation of the Scheme.
9.5. Had the proposed transfer taken place as at 31 December 2012, the transferring continental European
branch business portfolios of MSIEu would represent a large proportion (circa 97%) of the Technical
Provisions (net of reinsurance) of MSIG AG.
9.6. As the reinsurance contracts associated with the transferring business are transferred to MSIG AG as
described in Section 10, the net (of reinsurance) position of MSIG AG should not be adversely impacted as a
result of the Scheme.
9.7. I also considered in Section 7 the excess assets of MSIG AG post the transfer, from the perspective of the
Transferring Policyholders. While the net Technical Provisions of the transferring business are forecast to
represent a large proportion (circa 90%) of the overall MSIG AG net Technical Provisions at the Effective
Date of the Scheme, MSIG AG will also receive additional funds of €30 million (see paragraph 7.50 above).
As described in paragraph 7.91 above, the projected Solvency I Capital Cover Ratio is 5.6 compared to 22.9
pre-transfer (based on 31 December 2012 figures). Therefore, while the current MSIG AG policyholders will
experience a reduction in their Capital Cover Ratio and hence a reduction in security on a Solvency I basis, I
do not consider this reduction is likely to be material to the current MSIG AG policyholders, particularly
having regard to my comments in paragraph 7.82 above about the unusually large amount of Available
Capital in proportion to the MCR as at 31 December 2012. Furthermore, it should be noted that the forecast
Solvency I capital position described above for the MSIG AG (post Transfer) assumes that the benefit of the
additional funds of €30m (see paragraph 7.50 above) is neutral.
9.8. I have also assessed the Solvency II Capital Cover Ratios for MSIG AG pre and post the Transfer on the
assumption that the Scheme is implemented as at 31 December 2012 using the QIS5 standard formula. The
post Transfer Solvency II Capital Cover Ratio estimate of approximately 1.4 (allowing for the additional funds
of €30m – see paragraph 7.50 above) is less than the pre Transfer ratio of approximately 2.7 (excluding the
additional funds of €30m – see paragraph 7.50 above). Therefore, while the current MSIG AG policyholders
will experience a reduction in their Capital Cover Ratio and hence a reduction in security on a Solvency II
basis, I do not consider this reduction is likely to be material to the current MSIG AG policyholders,
particularly having regard to my comments in paragraph 7.82 above about the unusually large amount of
Available Capital in proportion to the Required Capital and Technical provisions as at 31 December 2012.
Conclusion
9.9. I believe that the Scheme is unlikely to have a materially adverse impact on the financial strength
(derived from excess assets and reserve strength) enjoyed by the current policyholders of MSIG AG
remaining after the proposed Scheme compared to both their current position and their projected
position at the Effective Date.
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The Change in Risk Exposure in MSIG AG
9.10. As mentioned in paragraph 9.7 above, if the Scheme is sanctioned, the net Technical Provisions of the
transferring business are forecast to represent a large proportion (circa 90%) of the overall MSIG AG net
Technical Provisions at the Effective Date. Thus, all other things being equal, this represents a large change
in risk exposure in MSIG AG as a result of the Scheme.
9.11. The transferring German branch business from MSIEu will have a similar risk profile to that of the current
MSIG AG business, as both entities write similar business. The transferring business from the other
continental European branches will, however, have a different risk profile with respect to, in the main, its
geographical distribution.
9.12. In addition, as mentioned in paragraph 7.123 above, the risks associated with the transferring business of
MSIEu are currently understood and managed by MSIEu and the knowledge and expertise associated with
these risks will in the main transfer to MSIG AG (including the continental European branches of MSIG AG)
after the Scheme.
9.13. Furthermore, the risk profile of the portfolio within MSIG AG (post-transfer) compared to that of the portfolios
of the transferring business of MSIEu or the current business of MSIG AG in isolation, would be expected to
improve, because of the benefit of the geographic diversification of the portfolio of risks, thereby reducing the
volatility of the claims experience. As such MSIG AG (post-transfer) would be expected to have both more
stable profits and to suffer proportionately smaller reserve deteriorations than for any one portfolio taken
individually.
Conclusion
9.14. I am satisfied that, although the Scheme will lead to a change to the risk exposures of the current
business of MSIG AG remaining after the proposed Scheme, this will not have a materially adverse
impact on the security of policyholder benefits.
Policy Servicing Levels in MSIG AG
9.15. Policies have been written within the (internal) German branch of MSIG AG since September 2012, while
MSIG AG‟s French branch commenced operations in July 2013. The majority of policyholders are expected
to arise from renewal of policies previously written within MSIEu, in respect of both JIA and non-JIA
business.
9.16. All policies within the (internal) German branch of MSIG AG are being handled using the Tainas
transactional system feeding into Oracle. I would reiterate the comment above that the Tainas system has
been independently reviewed and all matters arising from the review have been executed and completed.
9.17. Policies written in France are handled on a copy of the Marsys system identical to that used within the
French branch of MSIEu.
9.18. The main effect of the transfer on the current policyholders of MSIG AG will be a possible dilution of
resources available to meet this group‟s policy servicing requirements. However, the operational structure of
MSIG AG has been deliberately designed to support future business growth and to anticipate the policy
servicing requirements of the transferring policyholders of MSIEu as well as the current policyholders of
MSIG AG.
9.19. My comments above in respect of branch oversight and risk management apply equally to the current
policyholders of MSIG AG as to the transferring policyholders of MSIEu.
Conclusion
9.20. I believe that the Scheme is unlikely to have a materially adverse impact on the policy servicing
levels enjoyed by the policyholders of MSIG AG remaining after the proposed Scheme compared to
both their current position and their projected position at the Effective Date.
Conclusion for the MSIG AG Policyholders
9.21. For the reasons discussed above, I am satisfied that the proposed Scheme will not have a materially
adverse effect on the security of existing MSIG AG policyholders. Further, the service levels
provided to the policyholders in MSIG AG will not be adversely affected by the proposed Scheme.
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10. OTHER CONSIDERATIONS
The approach to communication with policyholders and reinsurers
10.1. Regulations made under the FSMA require a communication regarding the proposed transfer to be sent to
every policyholder of the parties to the Scheme unless the Court waives this requirement. However,
consideration may be given to the practicality and costs of sending notices against the likely benefits for
policyholders of receiving such communications. In order to comply with SUP 18.2.46G, the companies
would be expected to notify the policyholders, or interested persons, at least six weeks before the date of the
Court hearing at which the application to sanction the Scheme will be heard. The companies intend to
comply with this guidance.
10.2. I set out my understanding of the companies‟ proposed approach to communicating the Scheme to affected
policyholders below.
10.3. MSIEu proposes to:
send individual notification to all non-transferring policyholders of MSIEu directly or through brokers
(depending on the distribution channels used) who hold “live” policies;
send individual notification to all non-transferring policyholders of MSIEu who do not hold “live” policies,
but have active claims directly or through brokers or other intermediaries (claims representatives);
send individual notification to all transferring policyholders of the French, German, Italian, Belgian,
Dutch, Spanish and Slovakian branches of MSIEu directly or through brokers (depending on the
distribution channels used) who hold “live” policies;
send individual notification to transferring policyholders of the French, German, Italian, Belgian and
Dutch, Spanish and Slovakian branches of MSIEu who do not hold “live” policies, but have active claims
directly or through brokers or other intermediaries (claims representatives);
send notifications to the individual cedants in respect of the Qatar branch business (which is all inwards
reinsurance);
support the notification process by advertising in the London, Edinburgh and Belfast Gazettes, The
Times and Financial Times in the UK, and two national newspapers in each EEA state (in which a risk
under a direct policy is located) and Japan, one being a local newspaper and the other being the
international edition of the Financial Times; and
display information on its website, including the Circular (which will include the Scheme summary, a
summary of this Report and notice of the application to the Court for an order sanctioning the Scheme)
and a full copy of this Report will be posted. Details of the website will be included in the notices
advertised by MSIEu and the letters dispatched to policyholders, brokers and reinsurers with copies of
the Circular following the directions hearing.
10.4. MSIG AG proposes to:
send individual notification to all policyholders (including those of the French and Slovakian branches) of
MSIG AG directly or through brokers (depending on the distribution channels used) who hold “live”
policies;
send individual notification to all policyholders (including those of the French and Slovakian branches) of
MSIG AG who do not hold “live” policies, but have active claims directly or through brokers or other
intermediaries (claims representatives);
support the notification process by advertising in the London, Edinburgh and Belfast Gazettes, The
Times and Financial Times in the UK, and two national newspapers in each EEA state (in which a risk
under a direct policy is located) and Japan, one being a local newspaper and the other being the
international edition of the Financial Times; and
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display information on its website, including the Circular (which will include the Scheme summary, a
summary of this Report and notice of the application to the Court for an order sanctioning the Scheme)
and a full copy of this Report will be posted. Details of the website will be included in the notices
advertised by MSIG AG and the letters dispatched to policyholders, brokers and reinsurers with copies
of the Circular following the directions hearing.
10.5. Regulations made under the FSMA also require all reinsurers to be notified of a proposed transfer. MSIEu
and MSIG AG propose to notify all treaty reinsurers and facultative reinsurers that have been identified by
the information on reinsurance arrangements which give the name of reinsurer(s) for whom recoveries are
likely to be made, being those reinsurers with open or contingent balances. It should be noted that the treaty
reinsurers will be asked to accede to an endorsement (as explained in paragraph 10.17 below), i.e. the
treaty reinsurances will not transfer as part of the Scheme, instead MSIG AG is being added as a reinsured
to the policy, along with MSIEu (which is not being removed).
10.6. It will ultimately be for the Court to decide what notifications are required. This will be decided at a court
hearing after this Report is finalised and will be subject to any amendments required by the Court. It is
possible, therefore, that the actual approach to policyholder notification may differ in some respects from that
proposed and outlined above.
10.7. I am not aware of anything in the proposed approach to communication with policyholders and
reinsurers (as the case may be) that would have a material impact on any group of policyholders,
and therefore consider the proposed approach to be both proportionate and reasonable.
The Effect of the Scheme on the Reinsurance Asset
10.8. Where reinsurance contracts to be transferred under the Scheme are not governed by UK law, there is a risk
that reinsurers may challenge the Scheme and refuse to continue to meet their obligations under the
reinsurance contracts. Although some EEA law-governed reinsurance contracts should transfer under the
Scheme, others will not or might not do so.
10.9. The reinsurance asset associated with the transferring business was £113.8 million (with an additional £2.4
million of related deferred acquisition costs) as at 31 December 2012, i.e. a material part of the assets of
MSIEu.
10.10. This reinsurance asset (as 31 December 2012) is held in large part, over 75% by amount, with MSIJ (see
paragraph 7.18 above). The other external reinsurers of MSIEu are rated A (or better) by Standard & Poor‟s.
The reinsurance contracts associated with the asset may have differing governing law or seats of arbitration,
and as such a proportion of the reinsurance asset is potentially vulnerable as a result of the Scheme. The
financial status of MSIG AG could therefore be materially adversely affected should a material part of the
reinsurance asset not transfer under the Scheme.
10.11. It is proposed under the Scheme that only the facultative reinsurance arrangements which relate exclusively
to the Transferred Business be included in the Transfer. In order to assess the level of risk relating to the
transferring reinsurance asset, MSIEu has undertaken an exercise to identity all transferring facultative
reinsurance contracts, to categorise them according to the governing law or seat of arbitration, and, where
potential risks have been identified, establish actions to mitigate the risks as far as possible.
10.12. As at 31 December 2012, the ceded facultative outstanding loss reserves of MSIEu (valued at £30.5 million)
were distributed by domicile: 89% with MSIJ (a Japanese (re)insurer); 5% with UK based (re)insurers; 6%
with EEA (ex UK) based (re)insurers (there was also a very small proportion of ceded facultative outstanding
loss reserves with (re)insurers, other than MSIJ, outside the EU).
10.13. Had the Transfer taken place as at 31 December 2012, it can be seen that the relevant portion of the 93%
ceded facultative outstanding loss reserves of MSIEu (i.e. those contracts with MSIJ and UK domiciled
(re)insurers) would transfer under the Scheme (as MSIJ can reasonably be expected not to challenge the
Scheme). The remaining 6% of ceded facultative outstanding loss reserves of MSIEu (valued at circa £2m
as at 31 December 2012) are with EEA (ex UK) based (re)insurers (and of which only £0.1m is with
(re)insurers outside the EU) and would also be expected to transfer under the Scheme.
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10.14. I have been informed by the legal advisors to MSIEu in relation to the Scheme (and this is also the view of
the German lawyers I have retained in relation to the Scheme) that the EU (ex UK) reinsurance contracts are
likely to be governed by relevant EU laws, and the Scheme will be effective to transfer these agreements, as
the Court Order sanctioning the Scheme would be recognised under relevant EU laws enabling MSIG AG to
take proceedings in a relevant EU territory against a reinsurer for the payment of a reinsurance claim.
10.15. Furthermore, the facultative reinsurance contracts transferring under the Scheme are specific to the
Transferring Business, which will therefore continue to be protected post-Transfer in the same manner as
pre-Transfer, i.e. there will be no impact on the different groups of policyholders affected by the Scheme.
10.16. Thus, while there is a risk that the transferring (facultative) reinsurance asset provided by EEA (ex UK)
reinsurers may challenge the Scheme and refuse to continue to meet their obligations under the reinsurance
contracts, I do not consider this to be a risk that (should it manifest itself) would impact materially on the
financial status of MSIG AG post-transfer, because of the legal situation described above and that the key
EEA (ex UK) facultative reinsurers have an on-going relationship with MS & AD, e.g. Swiss Re.
10.17. In respect of other than facultative reinsurance arrangements, the reinsurers provide treaty cover which
relates to both the Transferred Business, and the business which remains with MSIEu after the Transfer (as
MSIEu and MSIG AG operate a joint reinsurance programme and will continue to do so until at least end
2014). It is therefore proposed that such reinsurance contracts be specifically excluded from the Transfer
(there being approximately 90 such reinsurers with exposure to the Transferred Business). It is further
proposed that they instead accede to the endorsement of the outwards reinsurance treaties with the name of
MSIG AG, in addition to MSIEu in respect of the Transferred Business.
10.18. As at 31 December 2012, the ceded treaty outstanding loss reserves of MSIEu (valued at £79 million) were
distributed by domicile: 74% with MSIJ (a Japanese (re)insurer); 2% with UK based (re)insurers; 19% with
EEA (ex UK) based (predominantly EU (ex UK) (re)insurers) and 5% with non-EEA based (re)insurers.
10.19. MSIEu therefore proposes to write to all reinsurers (as described in paragraph 10.5 above) to inform them of
the proposed Transfer, enclosing a copy of the Notice and Policyholder Statements and inviting them to
indicate whether they have any objections to the proposal and, in the case of treaty reinsurers, request their
accession to the endorsement of the reinsurance policies. I note that, based on advice received from the
German lawyers I have retained in relation to the Scheme, the endorsement of the treaty reinsurances (to
include MSIG AG as a co-reinsured) is the normal practice for “transferring” reinsurance contracts under
German legal/regulatory requirements.
10.20. I have reviewed a note prepared by MSIEu for the PRA dated 7 June 2013, which sets out the cover
provided to MSIEu by outwards treaty reinsurers who will be asked to accede to an endorsement of the
outwards reinsurance treaties with the name of MSIG AG, in addition to MSIEu. The note also considers a
potential worst case scenario in which some or all of the outwards treaty reinsurers decline the endorsement.
Based on my review of the analysis undertaken by MSIEu, it appears that only a small proportion of the
identified reinsurance asset is potentially vulnerable as a result of the proposed accession to an
endorsement.
10.21. The treaties proposed to be endorsed (so as to include MSIG AG as a co-reinsured) alongside the Scheme
effectively only apply to treaty years 2007 – 2011, because an endorsement to the treaties was made in July
2012 to add MSIG AG as a co-reinsured. Furthermore, MSIG AG was included as a co-reinsured on all 2013
treaties. Thus, the scope of the treaties subject to an endorsement is substantially reduced.
10.22. Therefore, there is a risk that the treaty (re)insurers (other than MSIJ) representing up to 26% of ceded
treaty outstanding loss reserves of MSIEu (as at 31 December 2012) may not accede to the endorsement (to
include MSIG AG as a co-reinsured). I do not consider this to be a risk that (should it manifest itself) would
impact materially on the financial status of MSIG AG post-transfer, because the key treaty reinsurers, such
as Swiss Re and Munich Re, have an on-going relationship with MS & AD, and the leading reinsurers have
already agreed to an endorsement on the 2012 treaties.
10.23. It is therefore my view (similar to that gleaned from the note prepared by MSIEu as described in paragraph
10.20 above) that only a small proportion of the treaty reinsurance asset is potentially vulnerable as a result
of reinsurers not acceding to the proposed endorsement on 2007 – 2011 treaties (i.e. to include MSIG AG as
a co-reinsured).
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10.24. With the exception of the 100% reinsurance arrangement (see paragraph 3.19 above) the endorsement of
the treaty reinsurances will simply allow MSIG AG to make claims against the relevant treaties in the same
manner that MSIEu would presently in respect of the Transferring Business. Therefore, with the exception of
the 100% reinsurance arrangement (see paragraph 3.19 above), the endorsement of the 2007 – 2011 treaty
reinsurances (i.e. to include MSIG AG as a co-reinsured) will not impact on the different groups of
policyholders affected by the Scheme.
10.25. In respect of the 100% reinsurance arrangement there are two parts (see paragraph 3.19 above). The
second part, i.e. for business earned on or after 1 October 2011, is a 100% reinsurance cover provided by
MSIJ. Therefore this part of the arrangement can be split simply according as to whether it is non-JIA
business of the German, French or Slovakian branches (i.e. part of the Transferring Business), which will be
to the benefit of MSIG AG, or the Qatar branch business (i.e. part of the business remaining in MSIEu) which
will be to the benefit of MSIEu. As such there is no adverse impact on the different groups of policyholders
affected by the Scheme arising from the endorsement of the 100% reinsurance arrangement as it applies to
the second part of the arrangement (i.e. for business earned on or after 1 October 2011).
10.26. The first part of the 100% reinsurance arrangement (see paragraph 3.19 above), i.e. the stop loss protection,
is essentially an Adverse Development Cover (“ADC”) in respect of earned reserves (net of all inuring intra-
group/external reinsurance) as booked in the management accounts of MSIEu as at 30 September 2011 for
non-JIA business. Therefore, if the projected ultimate claims develop adversely (post 30 September 2011)
this deterioration in experience is met by the ADC. In this way the MSIEu reserves (net of all inuring intra-
group/external reinsurance) as booked in the management accounts as at 30 September 2011 for non-JIA
business will not increase beyond this level (unless MSIJ itself were to fail).
10.27. I am advised by MSIEu that it proposes to the split of the ADC reinsurance asset between MSIEu and MSIG
AG as originally planned, i.e. by endorsement with MSIG AG becoming a co-reinsured, but also to provide
additional documentation that amends the current ADC, such that:
Pre 1 October 2011 non-JIA reserves are split into two sets being those relating to Transferring
Business (i.e. that of the German, French, and Slovakian branches of MSIEu) and those relating
to business remaining in MSIEu (i.e. that of the Qatar branch of MSIEu14
); and
deteriorations in either set of reserves are recoverable from MSIJ regardless of developments in
the other set.
10.28. In my view this approach is likely to be slightly more generous to each set of policyholders as recoveries will
no longer be dependent on the overall movement in reserves (i.e. a positive movement for one set of
policyholders would not offset, in whole or part, an adverse movement for the other set of policyholders), and
as such. there will be no adverse impact on the different groups of policyholders affected by the Scheme.
10.29. As described above, when MSIEu transfers the business to MSIG AG under the Scheme, the reinsurance
arrangements which support that business will transfer too, whether via the Scheme or by way of
endorsement. However, in order to replicate the policyholder security which MSIEu's policyholders currently
enjoy via the collateral arrangement with MSIJ (see paragraph 3.19 above), the collateral must transfer, at
least in part, to MSIG AG too. Accordingly, it is proposed that the LOC be amended to include MSIG AG as a
beneficiary. If the Tokyo Mitsubishi Bank is called upon to pay on the LOC, then it is proposed by MSIEu
that the split of the proceeds should be shared between MSIG AG and MSIEu according to their relevant
exposures to MSIJ on its insolvency. Such an approach does not seem unreasonable to me at this juncture,
but I recognise that MSIEu and MSIG AG (and their ultimate parent MSIJ) have not yet finalised the
approach that they wish to adopt nor has the apportionment of the LOC been formally documented.
10.30. While I understand that the terms of the LOC will simply name the two recipients of the proceeds, I further
understand that a separate agreement will be entered into between MSIG AG and MSIEu to specify the split
of the proceeds between them. Each will receive that proportion of the collateral which reflects their relevant
exposure to MSIJ, calculated as at the date of MSIJ's insolvency. Further details of this collateral split are to
be provided to me suitably ahead of the final Court hearing for the Scheme.
14
I note that the level of net reserves of the Qatar branch business covered by the first part of the 100% reinsurance arrangement was estimated to be $0.4 million as at 30 June 2013, i.e. very small in relation to the forecast Available Capital of MSIEu at the Effective Date.
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10.31. I will comment further on the position of the reinsurance asset transferring under the Scheme (or moving via
endorsement) to MSIG AG, and the split of the collateral/apportionment of the LOC (presently providing
security to MSIEu in respect of its reinsurance contracts with MSIJ) in my supplementary report (see
paragraph 1.26 above). In particular, by which time the extent of acceptance of the endorsement by relevant
treaty reinsurers should be largely (if not fully) known, and the details of the split of the proceeds of the
collateral arrangement with MSIJ should also be known. In addition, I will comment, as necessary, on the
German legal aspects of these various arrangements based on advice from the German lawyers I have
retained in relation to the Scheme.
10.32. I am satisfied that the reinsurance asset to be transferred will not be materially adversely impacted
under the proposed Scheme.
Assets and Liabilities of MSIEu and MSIG AG
10.33. As at 31 December 2012, the assets of MSIEu comprised of: fixed interest securities (valued at £81.1
million); variable interest securities (valued at £25.0 million); cash (valued at £79.5 million); debtors (valued
at £81.4 million); outwards reinsurance contracts (i.e. the reinsurance asset valued at £211.3 million); and
other assets (valued at £10.1 million). Of the total assets £3.2 million were deemed to be inadmissible for
Solvency I asset valuation purposes. The characteristics of the fixed interest and variable interest securities
(totalling £106.1 million) are as follows:
The average duration and yield to maturity is 0.9 years and 0.5% gross per annum respectively;
All securities have a credit rating of A- or better;
The currency split is 55%, 40% and 5% in GBP, EUR and USD respectively.
10.34. As at 31 December 2012, the assets of MSIG AG comprised of: short-term deposits denominated in Euros
with „A‟ and above rated banks (valued at €78.1 million); cash (valued at €4.2 million); debtors (valued at
€4.1 million); outwards reinsurance contracts (i.e. the reinsurance asset valued at €2.2 million); and other
assets (valued at €1.1 million). The other assets are largely made up of intangibles, and would therefore be
inadmissible for Solvency I asset valuation purposes.
10.35. The assets to be transferred from MSIEu to MSIG AG under the proposed Scheme will be of equal value to
the Technical Provisions (gross of reinsurance) and other insurance related liabilities (“Total Liabilities”) at
the Effective Date for the Transferring Business (which amounted to £217.0 million as at 31 December 2012,
excluding any amount for Equalisation Provisions) plus an amount of €30 million15
. These assets will be
almost wholly comprised of: fixed interest securities (valued at £45.6 million as at 31 December 2012); cash
(valued at £10.7 million as at 31 December 2012); debtors (valued at £44.1 million as at
31 December 2012); and outwards reinsurance contracts (i.e. the reinsurance asset valued at £113.8 million
as at 31 December 2012). The balance (if any) will be made up of a small amount of other assets such as
deferred acquisition costs.
15
As per the letter of intent (as described in paragraph 7.51 above), MSIGHE commits to maintain the capital position of MSIEu at the level projected at the Effective Date (as per the current 2013 Business Plan for MSIEu) for a period of at least six months following the Effective Date, i.e. the commitment essentially neutralises the €30 million of assets transferred over and above the assets representing the Total Liabilities at the Effective Date for the Transferring Business.
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10.36. Had the Transfer taken place as at 31 December 2012:
The reinsurance asset transferring (or in the case of reinsurance treaties being moved via
endorsement) to MSIG AG would have amounted to £113.8m, i.e. the ceded Technical Provisions in
respect of the Transferring Business. Thus the remaining ceded Technical Provisions in MSIEu would
have amounted to £97.5m, i.e. those specific to the business remaining after the Transfer;
The investments transferring to MSIG AG would have amounted to £45.6m, made up of £42.5m of Euro denominated bonds and £3.1m of GBP denominated bonds (i.e. the currency of the investments very closely matches that of the net Technical Provisions of the Transferring Business amounting to £43.8m, including deferred acquisition costs). Thus the remaining reinsurance asset in MSIEu would have amounted to £60.4m, made-up of £55.4m of GBP denominated bonds and £5.0m of USD denominated bonds. The net Technical Provisions of the business remaining in MSIEu as at 31 December 2012 amounted to £32.1m, including deferred acquisition costs (i.e. the GBP denominated bonds more than cover the net Technical Provisions of the remaining business, which are themselves over 95% denominated in GBP). Further, the mix of the bonds by average duration, yield and credit rating is similar by currency. Therefore, in my view the quality of the investments transferring to MISG AG is not of materially different to the quality to those investments staying in MSIEu;
The cash transferring to MSIG AG would have amounted to £10.7m, i.e. that held in accounts in the name of the transferring branches for their day-to-day operational purposes. The remaining cash in MSIEu of £68.7m held in a combination of term deposits and current accounts was with banks rated A- or above and diversified such that no bank holding represents more than 5% of total investments (including cash);
The debtors transferring to MSIG AG would have amounted to £44.1m, i.e. those specific to each of the transferring branches. The remaining debtors in MSIEu of £37.3m were those specific to the UK business (and the Qatar branch), including centrally held treaty reinsurance recoveries.
10.37. Based on my observations above, had the transfer taken place as at 31 December 2012, I believe the quality
of the assets transferring to MSIG AG would not have been materially different to the quality to those assets
staying in MSIEu.
10.38. In addition to the assets transferring in respect of the Transferring Business, MSIEu will also transfer a
further €30m of cash assets as described in paragraph 7.50 above.
10.39. In my view the type and nature of the assets to be transferred does not generate any material
additional risk to the security of the policyholders of MSIG AG, including the transferring
policyholders of MSIEu Furthermore, I am satisfied that the assets remaining in MSIEu at the
Effective Date do not generate any material additional risk to the security of the policyholders of
MSIEu not transferring under the proposed Scheme.
Operational Plans and Changes in Assets and Liabilities up to the Effective Date
10.40. I expect that the current activities of MSIEu and MSIG AG will continue between 31 December 2012 and the
Effective Date (and, as appropriate, after the Effective Date). MSIEu and MSIG AG will continue to write new
and renewal business and the companies will continue to settle claims and reassess reserves in the light of
experience. I do not consider that any material additional risk to any group of affected policyholders will
emerge as a result of the continuation of normal business.
10.41. Further to considering the continuation of normal business, I have discussed separately with MSIEu and
MSIG AG the possibility of management actions that could affect the financial position of MSIEu and MSIG
AG (such as corporate restructuring or significant changes in new business strategy or operational plans). I
have been informed that MSIG AG has no planned activities (other than the receipt of the Transferring
Business under the proposed Scheme) that would have a material effect on the security of its policyholders,
either for those that were policyholders as at 31 December 2012 or those that have become policyholders
since then.
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10.42. In the case of MSIEu, the company‟s business profile will be substantially smaller after the proposed
Scheme is implemented, and it is therefore in the process of realigning its expense base with the level of
new (and renewed) business expected after the Effective Date (see Section 8). MSIEu have provided me
with a document giving details of financial projections, including the capital available, over the next 5 years,
allowing for reduced levels of new (and renewed) business, and a transition to an expense level that is
consistent with the (reduced) volume of business. This document shows that the company will be well
capitalised throughout the 5 year projection period (relative to its ICG, on the basis that the ICG remained at
the same percentage of ECR as previously confirmed to MSIEu by the FSA in 2011). I therefore do not
believe the change in new business strategy of MSIEu (i.e. reduced volumes of business and lower levels of
expenses) is likely to have a material effect on the security of its policyholders, either for those that were
policyholders as at 31 December 2012 or those that have become policyholders since then.
10.43. A short time before the final Court hearing, I will consider the extent to which the operational plans (including
policy servicing) of MSIEu and/or MSIG AG have altered (relative to the position at the date of this Report)
and the actual changes in assets and liabilities (relative to the position as at 31 December 2012) and hence
whether there have been any changes (including those associated with current economic conditions) that
would affect my overall opinion, and will report on these as part of my supplementary/update report (see
paragraph 1.26 above).
Solvency II
10.44. As described in Section 2, the regulatory solvency reporting requirements for EU insurers and reinsurers are
presently expected to undergo a major overhaul from, at the earliest, the beginning of 2016.
10.45. It is important to note that these requirements have not yet been finalised so any comments in this sub-
section are based on the detail available to me at the time of writing this Report. It is almost certain that final
requirements will vary from the current understanding, and possibly substantially so. This should be borne in
mind when reading this sub-section.
10.46. Whether or not the proposed Scheme is implemented both MSIEu and MSIG AG will need to comply with
Solvency II when it takes effect, and each company plans to use the standard formula approach to assess its
SCR.
10.47. While my assessment of the impact on policyholder security has been made on the basis of Solvency I and,
for MSIEu, the current ICA regime, I have also considered the security of policyholders on the basis of the
impending Solvency II regime.
10.48. In order to consider the potential impact of Solvency II (given that the current rules surrounding the Solvency
II regime have not yet been finalised) I have used the most relevant quantitative information available for
both MSIEu and MSIG AG.
PREPAREDNESS FOR SOLVENCY II
10.49. There is a significant amount of work for all insurance companies to do in preparing themselves for the new
Solvency II regime. Nonetheless, I am informed that the Lloyd‟s operation of MS & AD is fully prepared for
Solvency II, subject to the requirements of the Solvency II regime needing to be finalised (see paragraph
10.45 above).
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10.50. I have held separate discussions with MSIEu and MSIG AG about their respective Solvency II
implementation plans. Based on my discussions with MSIEu, I summarise the position of its preparation for
Solvency II as follows:
The MSIEu Solvency II programme was initiated in May 2012 following the completion of the RP
(see paragraph 3.29 above). A gap analysis was carried out to determine what further work was
needed post the RP to make MSIEu Solvency II compliant. The output of the gap analysis formed
the scope of the Solvency II programme which was communicated to the FSA on 2 July 2012. All
current MSIEu branches are within the scope of the programme. The original aim of the
programme was to achieve compliance across Pillars I, II & III by the end of 2013. The scope was
revised following the FSA announcement on 22 October 2012 that the Solvency II timetable would
be put back. The current aim is compliance with Pillar II by the end of 2013. Data analysis for
Pillars I and III has been completed and the capability to run the standard formula has been
embedded, but no further work is planned on these Pillars until the final calibrations of the standard
formula are received from EIOPA and clarity is provided around the implementation date;
The plans are monitored fortnightly, and progress is monitored via a weekly meeting. The
programme is governed by a monthly MSIEu Solvency II Steering Group meeting, chaired by the
current Chief Financial Officer who is an active sponsor with significant prior experience of
Solvency II (as an active sponsor of the MS & AD Lloyd‟s operation Solvency II Programme);
The Internal Control Framework has been implemented (the Management & Committee structures
being implemented as part of the RP). The Risk Management Framework and associated
processes have been implemented. Compliance policies and procedures have been documented.
Outsourcing policies and procedures have been documented and a database of contracts
produced. Underwriting and Reinsurance oversight processes have been strengthened. The
implementation of the Data Policy and Data Governance Framework has been deferred as it is
linked to Pillars I & III, i.e. to ensure the accuracy for the data feeding the standard formula and
Pillar III reports. This work is anticipated to be restarted in 2014 when the Solvency II
implementation date becomes clearer;
The programme is on target to deliver compliance with Pillar II in 2013. The Solvency II Steering
Group has agreed to close the programme at the end of July 2013 and deliver the outstanding
requirements as BAU to reduce programme management overheads;
The Solvency II Steering Group is chaired by the Group Finance Director and is attended by the
Chief Executive Officer. It is also attended by 2 members of MSIGHE. The Risk Officer of MSIG
AG also attends to represent its interest in the programme;
The MSIEu Solvency II programme continues to have responsibility for Pillar II compliance in all
current MSIEu branches, including those that will transfer to MSIG AG under the proposed
Scheme.
10.51. From paragraph 10.50 above it can be seen that MSIEu has Board engagement for its Solvency II project,
and is making progress in line with its implementation plan.
10.52. For the purposes of setting capital requirements, MSIEu intends to use the “Standard Formula” approach.
10.53. Furthermore, MSIEu will utilise/adopt, as necessary, the processes developed by the MS & AD Lloyd‟s
operation for its own business.
10.54. From my conversations and my review of the materials I have received, and subject to the likely delay to
Solvency II implementation discussed above, which may slow MSIEu‟s preparation work, I have not
identified any reasons why MSIEu should not be able to meet its Solvency II plan objectives in time for
Solvency II implementation (on or after 1 January 2016).
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10.55. Based on my discussions with MSIG AG, I summarise the position of its preparation for Solvency II as
follows:
MSIG AG's approach to achieving Solvency II compliance has been to leverage the work carried
out by the MSIEu Solvency II programme, adapting deliverables where necessary to meet MaRisk
VA requirements. The MSIEu Solvency II programme is on target to implement Pillar II compliant
processes into MSIEu's Head Office and all transferring branches by 1 January 2014. MSIG AG
has participated actively in this programme since November 2012 and is represented by the
company‟s risk officer at the monthly MSIEu Solvency II Programme Steering Group meeting. In the
first quarter 2013, plans for MSIG AG Solvency II compliance were integrated into the MSIG AG
Operational Transition plan to ensure that the MSIG AG Head Office implements Solvency II
compliant policies and processes at the outset. The MSIG AG Operational Transition plan (of which
the Scheme is a part) comprises 9 separate work-streams which produce the deliverables required
for MaRisk VA/Pillar II compliance. Work-stream plans are updated weekly and progress is
monitored by the monthly JPB meeting. The MSIG AG Operational Transition project is currently
progressing to schedule. (It should also be noted that the MSIEu Solvency II programme continues
to have responsibility for implementing Pillar II compliance within the transferring branches);
Management Board engagement in the MSIG AG Solvency II project is achieved by: (a) Solvency II
updates being a standing item on the Management Board meeting agenda; (b) the Chief Executive
Officer and the Chief Financial Officer attending the regular weekly MSIG AG Operational
Transition project progress meetings, which include monitoring of progress on Solvency II items;
and (c) the Chief Underwriting Officer, who was until recently a member of the MSIEu Solvency II
Steering Group and sponsor of the MSIEu Solvency II Underwriting and Reinsurance work-streams,
continuing to attend the MSIEu Underwriting & Claims Committee as well as the MSIEu
Reinsurance Committee);
The company has already achieved a high degree of MaRisk VA/Pillar II compliance. A
management and committee structure has been implemented that meets MaRisk VA requirements.
The remainder of the MSIG AG corporate governance policies and processes have been adopted
(with, as necessary, appropriate adjustments) from the MSIEu Solvency II compliant versions and
implemented in MSIG AG. This applies to the Branch Oversight Framework, the Risk Management
Framework, Audit, Compliance and Outsourcing policies and processes. Approximate QIS5
calculations have also been delivered to meet requirements for the Operational Transition project.
These calculations are planned to be supplemented with an MSIEu-style ORSA process and
reports (including capital allocation) in the third quarter of 2013. Evidence templates will be
produced in the third quarter of 2013 to demonstrate how MaRisk VA & Solvency II requirements
have been addressed;
Where MSIG AG has adopted (with, where necessary, appropriate adjustments) MSIEu policies
and processes for its Head Office these will be Solvency II compliant. Work-stream leads from the
MSIEu Solvency II programme are currently producing evidence templates to demonstrate how
they have achieved Solvency II compliance within their work-stream.
10.56. From paragraph 10.55 above it can be seen that MSIG AG has Board engagement for its Solvency II project.
10.57. For the purposes of setting capital requirements, MSIG AG intends to use the “Standard Formula” approach.
10.58. Furthermore, MSIG AG will utilise/adopt, as necessary, the processes developed by the MSIEu Solvency II
programme for its own business.
10.59. From my conversations and my review of the materials I have received, and subject to the likely delay to
Solvency II implementation discussed above, which may slow MSIG AG‟s preparation work, I have not
identified any reasons why MSIG AG should not be able to meet its Solvency II plan objectives in time for
Solvency II implementation (on or after 1 January 2016).
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QIS5 (STANDARD FORMULA)
10.60. The rules for the new Solvency II regulatory framework have not been finalised, but draft guidance has been
issued and Quantitative Impact Studies have been used to assess the potential impact on regulatory capital
requirements.
10.61. The proto-type Solvency II standard formula is calibrated at a 99.5% level over a one year time horizon (i.e.
a 1 in 200 probability of a company not meeting its obligations in the coming year). This means that if a
company meets this requirement, then the probability of meeting its obligations over the next year is greater
than the 1 in 200 level.
10.62. The latest quantitative impact assessment can be obtained from applying the methodology from the fifth
Quantitative Impact Study (as amended, supplemented or replaced at the time of calculation). I refer to this
capital assessment as “QIS5”.
10.63. In order to consider the potential impact of Solvency II (given that the rules surrounding the Solvency II
regime have not yet been finalised), I have used the most recent standard formula information available to
the companies.
10.64. Similar to my consideration of capital being sufficient relative to Solvency I, and for MSIEu the ICA regime
too, I have described capital as being “sufficient” within the context of Solvency II when it meets the
benchmark level equivalent under QIS5.
10.65. The QIS5 assessment involves the application of formulae designed to be applicable to all insurance
companies and is therefore not tailored to the particular circumstances of an individual company (as per the
ICA for MSIEu). The QIS5 assessment is, however, the best current indication of the likely regulatory capital
requirement once Solvency II comes into force. I have referred to the pre and post Transfer QIS5
calculations in order to assess the extent to which MSIEu and MSIG AG are likely to meet their respective
regulatory capital requirements after the Transfer if Solvency II were then to be in-force.
10.66. I have performed a review of the QIS5 analyses produced by MSIEu and MSIG AG. I have asked questions
in relation to specific aspects of the analysis in order to ensure my understanding of the analyses conducted
and I have received satisfactory answers to these questions.
10.67. I note that the rules for Solvency II are not yet finalised and are subject to change. It will no doubt take some
time, even after Solvency II is formally introduced, before market practice in interpreting the guidance is fully
established. Finally, I note that the Standard Formula itself may be altered before Solvency II comes into
force and that the QIS5 spread-sheet analyses performed by MSIEu and MSIG AG are unaudited
POLICYHOLDER SECURITY OVER PERIODS GREATER THAN ONE YEAR
10.68. As described in paragraph 10.61 above, QIS5 is calibrated at a 99.5% level over a one year time horizon. I
therefore also need to consider the security provided to the transferring policyholders of MSIEu over time
periods greater than one year. This is because it is likely to take many years for all the insurance claims of
MSIEu to be settled. The question of policyholder security is therefore relevant over the whole period in
which claims are likely to be settled (i.e. to ultimate), and not just the next 12 months.
10.69. In order to address this question I have considered the modelling work carried out by MSIEu for its ICA to
assess the likelihood of the company meeting all payments to its creditors/policyholders (regardless of
whether these payments occur in the next year, next two years, next three years etc.)
10.70. For its ICA as at 31 December 2012, MSIEu used a risk tolerance level of 99.5% (i.e. the level acceptable to the PRA based on a one year new business time horizon) to assess the capital to be able to pay all insurance claims (over all periods). This means that the requirement from the PRA is that MSIEu holds sufficient capital to be able to pay all insurance claims with a probability of 99.5% (i.e. 199 times out of 200). As summarised in paragraph 7.75 above, the capital modelling work carried out by MSIEu indicates that the company is well-capitalised as at 31 December 2012 on an ICA basis.
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10.71. MSIEu‟s ICA amount, based on its calculations as at 31 December 2012, was lower than the corresponding
QIS5 SCR as at 31 December 2012. However, the calculation of the excess assets (Available Capital) is
also different between QIS5 and the ICA. Nonetheless, the excess assets calculated under the ICA and
those calculated under QIS5 were broadly equivalent as at 31 December 2012. As a result, the surplus of
Available Capital over Required Capital as at 31 December 2012 was greater under the ICA calculation than
under the QIS5 calculation. I therefore believe that the QIS5 assessment will be at least as strong as the
ICA, despite being calibrated to a one-year time horizon, rather than to exhaustion of the liabilities. In other
words, it is likely that that capital levels assessed on a QIS5 basis will be at least as great as would be
required under an ICA, while noting that the rules for the new Solvency II regulatory framework have not
been finalised. Furthermore, as explained in paragraph 7.117 above, at the Effective Date the policyholders
of MSIG AG, including the transferring MSIEu policyholders, benefit from the MSIJ Credit Support Guarantee
for MSIG AG, and as such will have their claims met by MSIJ should there be a failure of MSIG AG.
Conclusion
10.72. I do not believe the Scheme will impact in a materially adverse manner the approach of MSIEu or
MSIG AG to meeting and complying with Solvency II requirements. In addition, based on proto-type
Solvency II standard formula calculations, both MSIEu and MSIG AG are projected to have sufficient
capital resources to meet their respective SCRs.
The MSIEu and MSIG AG Pension Schemes
10.73. The funding and operation of the respective pension schemes of MSIEu and MSIG AG will not be affected
by the Scheme.
Supervision
10.74. At present MSIEu is regulated by the PRA/FCA. If the Scheme is sanctioned, the business of MSIG AG
(including the transferring MSIEu policyholders on the Effective Date) will be fully regulated by BaFin.
Further, both the PRA/FCA and BaFin operate in accordance with relevant EU directives.
10.75. While I am in no position to comment on the impact of moving to full BaFin supervision for the transferring
MSIEu policyholders, I would expect suitable discussion and agreement between the regulators (the
PRA/FCA and BaFin) if the need were to arise.
Tax
10.76. I am informed by MSIEu (based on preliminary advice from their external tax advisers) that the proposed
Scheme is not expected to have tax implications that would materially adversely affect any policyholders
impacted by the transfers under the Scheme.
Costs of the Scheme
10.77. The external costs of the Scheme will be met by MSIG AG. No costs are expected to be borne by
policyholders.
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11. CONCLUSIONS
11.1. In summary, in my opinion, provided the proposed Scheme operates as intended, and I have no grounds for
believing it will not do so:
The security of benefits of policyholders of MSIEu and MSIG AG will not be materially adversely
affected by the implementation of the Scheme on the Effective Date;
The Scheme will not have a materially adverse impact on service standards experienced by the
policyholders of MSIEu and MSIG AG.
11.2. In reaching this opinion I have applied the following principles (as set out in the Transformations TAS):
I have exercised my judgement in a reasoned and justifiable manner;
I have considered which parties might be affected by the Scheme and in what way. I have
documented my findings;
Where I have used the results of models developed and operated within MSIEu or MSIG AG (as the
case may be), I have reviewed documentation describing the models, describing and justifying the
assumptions underlying those models, and explaining the derivation of the data underlying the
models and assumptions, in particular explaining how its accuracy, completeness and relevance
has been verified;
To the best of my knowledge there are no beneficiaries for whom the impact of the Scheme has not
been considered;
I have not restricted my assessment of the change in the security of the benefits of any group to
adverse impacts only;
I have considered how the Scheme might lead to any changes in the material risks to the benefits of
the different interested parties;
I have considered the impact on the actuarial information provided to me of MSIEu or MSIG AG (as
the case may be) having adopted alternative plausible assumptions, for example in the scenario
and sensitivity tests within the MSIEu or MSIG AG financial projections (as the case may be);
I have described the impact of the Scheme on all classes of beneficiaries;
I have included details of the rationale proposed by MS & AD for the Scheme to proceed;
I have included (in summary) the information on which my opinion is based;
I have described the rationale for my opinion.
Gary Wells 23 August 2013
Fellow of the Institute and Faculty of Actuaries
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APPENDIX 1. DEFINED TERMS
Accident Year The year to which a claim is allocated based on the date of that accident/claim.
Admissible Assets Assets valued in accordance with applicable regulations, which can be taken into account for the purposes of demonstrating that a general insurance company meets its solvency requirements.
Capital Charge In relation to a risk identified by a firm to which it is exposed, e.g. market risk, the amount of capital calculated to mitigate appropriately that risk that could otherwise cause the firm to be unable to meet its liabilities as they fall due.
Correlation Correlation (in the context of this Report) is a number that describes the statistical relationship between two variables (e.g. equity prices and interest rates).
EIOPA The European Insurance and Occupational Pensions Authority.
Enhanced Capital Requirement (“ECR”)
A more risk sensitive and targeted capital requirement (than the MCR) for UK insurers as measured by the PRA/FCA. The ECR is not a publically available figure.
Equalisation Provisions
An equalisation provision is a provision built-up according to a formula prescribed by regulation (generally from profitable years) as a cushion against periods with worse than average claims experience.
PRA/FCA Returns Accounts, balance sheets, abstracts and statements relating to the business of an insurance company required under PRA/FCA rules to be submitted periodically to the PRA/FCA.
Individual Capital Assessment (“ICA”)
An insurance company‟s own assessment of the capital it needs for regulatory purposes in order to mitigate appropriately the risks to which it is exposed and that could otherwise cause it to be unable to meet its liabilities as they fall due.
Individual Capital Guidance (“ICG”)
The PRA/FCA‟s assessment of the minimum level of capital that it would expect an insurance company to hold based on its view of the insurance company‟s ICA and risk management framework.
Minimum Capital Requirement (“MCR”)
Required minimum level of capital under Solvency I rules. See Appendix 5 for further details.
QIS5 QIS5 is the fifth quantitative impact study to test the financial impact and suitability of proposed Solvency II requirements on insurers. QIS5 is the most recent quantitative impact study, conducted in 2010.
Quota Share Reinsurance
A form of reinsurance in which the insurer passes on an agreed percentage of every risk it insures that falls within a class or classes of business (subject to a reinsurance treaty) to the reinsurer.
Reinsurance An arrangement with another insurer whereby risks are shared (or passed on).
Solvency I The system for establishing minimum capital requirements for EU insurers under relevant EU Directives presently in force.
Technical Provisions Liabilities determined for regulatory purposes. In particular, the provisions for the ultimate costs of settling all claims arising from events which have occurred up to the balance sheet date, including provision for claims incurred but not yet reported, less any amounts paid in respect of these claims; plus the provisions for future claims arising on unexpired periods of risk.
Underwriting Year The year to which a claim is allocated based on the date of inception of the policy to which that accident/claim relates.
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APPENDIX 2. LIST OF PREVIOUS TRANSFERS FOR WHICH I HAVE ACTED AS THE INDEPENDENT EXPERT OR EQUIVALENT
1997: Transfer of the PHI business from Norwich Union Limited to Norwich Union Life & Pensions Limited
1997: Transfer of business from Security Assurance Limited to Norwich Union Life & Pensions Limited
1999: Transfer of the business of London & Edinburgh Life to Norwich Union Life & Pensions Limited
2004: Transfer of the business of the Continental Reinsurance Company (UK) Limited to Continental Management Services Limited
2005: Transfer of the business of the UK branch of the Continental Insurance Company to Continental Management Services Limited
2006: Transfer of the IGI portfolio of CX Reinsurance Company Limited to CNA Insurance Company Limited
2008: Transfer of the Irish branch business of Royal & Sun Alliance Insurance plc to Europa General Insurance Company Limited
2009: Transfer of business from Arran Insurance Company Limited to Chevanstell Limited
2010: Transfer of business from Euler Hermes Guarantee plc to Euler Hermes UK plc
2011: Transfer of business from Euler Hermes UK plc to Euler Hermes Belgium
2011: Transfers of business from PA(GI) Ltd to Royal & Sun Alliance Insurance plc and Marine Insurance Company Limited
2011: Rationalisation of 22 UK regulated entities of Royal & Sun Alliance Insurance plc to 5 UK companies via 3 Part VII transfer schemes (effective 1 January 2012)
2013: Transfer of certain business of the Italian branch of Sompo Japan Insurance Company of Europe Limited to Berkshire Hathaway International Insurance Limited.
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APPENDIX 3. EXTRACT OF THE SCOPE OF THE WORK OF THE INDEPENDENT EXPERT IN RELATION TO THE SCHEME
The Independent Expert‟s Report will consider the terms of the Scheme generally and the effect which the Scheme will have on the holders of (re)insurance policies of MSIEu and MSIG AG (collectively the “Companies”).
The Independent Expert‟s review and report will address generally the way in which the Companies have conducted their insurance business but taking into account the particular circumstances of each of the different groups of policyholders of the Companies involved in the Scheme. It will deal inter alia with the following aspects:
The likely scope for deteriorations in each of the Companies‟ claims reserves (i.e. the likelihood and extent to which each of the Companies‟ reserves may prove inadequate);
The impact of the Scheme on the security/financial strength of the different groups of policyholders of the Companies involved in the Scheme;
The impact of the Scheme on the levels of service provided to the different groups of policyholders of the Companies involved in the Scheme;
The existing and proposed agreements (if any) between the Companies and their reinsurers;
Guarantees and/or agreements (if any) between the Companies;
Guarantees and/or agreements (if any) between each of the Companies and their respective parent company;
Transactions (including other portfolio transfers and commutations) that impact upon the Companies;
The terms and conditions (if any) expected to be imposed by the Scheme to be presented to the Court;
The matters required by applicable provisions of SUP18.2.31 to 18.2.41 of the FSA Handbook;
A review of the communications made to policyholders;
Any other matters drawn to my attention by the FSA or which are required by the FSA to be addressed within the report.
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APPENDIX 4. KEY SOURCES OF DATA
In writing this report, I relied upon the accuracy of certain documents and spreadsheets provided by MSIEu and MSIG AG. These included, but were not limited to the following:
A4.1 I have used the following documents, reports, data and other information provided by MSIEu and MSIG AG:
Internal note prepared by MSIEu dated 23 May 2012 outlining the proposal to Part VII transfer MSIEu to an MSIG entity based in continental Europe.
Actuarial reserve review reports produced by external actuaries for MSIEu as at 31 December 2012.
Draft internal reserve review summary for MSIEu as at 31 December 2012 prepared for Board Meeting.
Annual Report and Financial Statements for MSIEu prepared as at 31 December 2012.
FSA regulatory returns (and Form ECR1) for MSIEu as at 31 December 2012.
Financial Statements for MSIG AG as at 31 December 2012.
ICA commentary as at 31 December 2012 for MSIEu.
QIS5 results as at 31 December 2012 produced by MSIEu (and supporting QIS5 spreadsheets).
QIS5 results as at 31 December 2012 produced by external actuaries for MSIG AG (and supporting QIS5 spreadsheets).
Internal note and spread-sheets prepared by MSIEu and MSIG AG providing an overview of the MSIEu outwards reinsurance programme.
Spreadsheet schedule of investments for MSIEu prepared as at 31 December 2012.
Documents submitted to BaFin supporting MSIG AG‟s authorisation application and subsequent correspondence between BaFin and MSIG AG.
Draft scheme documents for the Scheme.
Draft MSIEu Strategy & Business Plan 2014 – 2018 (dated 26 June 2013).
Draft Letter of Intent from MSIJ
Letter of Intent from MSIGHE signed and dated 8 August 2013
MSIL Board resolution on 19 July 2013
MSIGHE Board resolution on 19 July 2013
Internal Audit Review report prepared by the internal audit function of MSIG AG
A note prepared by MSIEu entitled MSIEu Part VII transfer – Split of 100% reinsurance and letter of credit.
A4.2 Information relating to the items listed above was also gathered during meetings with staff of MSIEu and MSIG AG.
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APPENDIX 5. MINIMUM CAPITAL REQUIREMENT
A5.1 The solvency regimes in the two jurisdictions (the UK and Germany) while different are both subject to a minimum level based on EU Directives. The differences in the solvency regimes in the two jurisdictions can be summarised as set out below.
UK
A5.2 In the UK the process of setting minimum solvency margins changed with effect from 2005. Nonetheless, UK general insurers continue to have to meet statutory requirements based on EU Directives and, for the time being, provide their risk-based enhanced capital requirement (ECR) calculation to the PRA in private. In addition, all UK general insurers are required to make their own individual capital assessment (ICA) of their own capital needs which will be used by the PRA when giving individual capital guidance.
A5.3 The minimum capital requirement (MCR) based on EU Directives is outlined below.
A5.4 The MCR is the greater of a premium measure, a claims incurred measure and a prior year MCR measure, subject to a minimum amount of €3.7 million. The premium measure (A) is based on the premium amount (P), which is the greater of gross written and earned premiums in the past year, with the amount being increased by 50% for premiums in respect of marine liability, aviation and general liability business, and decreased by two-thirds for premiums in respect of “actuarial health insurance”. (A) is calculated as follows:
If P ≤ €61.3 million then A1 = P 18%, A2 = 0
If P > €61.3 million then A1 = €11.0 million, A2 = (P - €61.3 million) 16%
A = A1 + A2
A5.5 The loss provision measure (B) is based on the claims amount (C), which is generally calculated as the gross claims incurred over the previous three years, with claims in respect of marine liability, aviation and general liability business being increased by 50%, and claims in respect of “actuarial health insurance” decreased by two-thirds. of as follows: (B) is calculated as follows:
If C ≤ €42.9 million then B1 = C 26%, B2 = 0
If C > €42.9 million then B1 = €11.2 million, B2 = (C - €42.9 million) 23%
B = B1 + B2
A5.6 A credit for reinsurance factor (r) is then determined as the ratio of net incurred claims over the 3 year period (to the valuation date) to gross incurred claims ratio over the same 3 year period. If r < 0.5 then r is set to 0.5.
A5.7 Prior year amount (M) is based on the prior year MCR and changes in outstanding claims:
Where net outstanding claims are greater than zero as at the end of the current and previous
financial years:
M = Prior year MCR min(1, net outstanding claims as at the end of the current financial year
divided by the net outstanding claims as at the end of the previous financial year);
Where net outstanding claims are zero as at the end of the current and previous financial years:
M = Prior year MCR min(1, gross outstanding claims as at the end of the current financial year
divided by the gross outstanding claims as at the end of the previous financial year);
Where gross outstanding claims are zero as at the end of the current and previous financial year:
M = MCR as at the end of the previous financial year.
A5.8 Minimum solvency margin = max {max (A,B) r, M, €3.7 million}
Milliman Report
Report of the Independent Expert on the proposed transfer of the insurance business of certain of the branches of MSIEu to MSIG AG
August 23, 2013 75
A5.9 The monetary amounts stated above are those applicable from 31 December 2012 and subject to an annual increase by the percentage change in the European index of consumer prices. The sterling value of the euro for insurance regulatory purposes for the 12 month period beginning 31 December 2012 is 80.645 pence
16.
Germany
A5.10 The minimum capital requirement for an insurer in Germany is calculated as described above for the UK. There are no further regulatory capital requirements. However, as will also apply in the UK, German insurers will be required to establish capital levels in accordance with the EU-wide Solvency II regime (the formal date for implementation is now expected to be 1 January 2016, although it could be delayed).
16
See http://www.fsa.gov.uk/about/who/management/teams_1/insurance/value
Milliman Report
Report of the Independent Expert on the proposed transfer of the insurance business of certain of the branches of MSIEu to MSIG AG
August 23, 2013 76
APPENDIX 6. MARISK (VA)
Introduction
A6.1 In its MaRisk VA Circular, published in January 2009, BaFin sets out the supervisory minimum requirements for risk management. Within the meaning of the Circular, risk management includes the definition of an appropriate risk strategy consistent with the chosen business strategy, adequate organisational and operational rules, the establishment of an appropriate internal risk treatment and control system, as well as the establishment of an internal auditing system and the implementation of internal controls. Management is to adequately and regularly inform the supervisory body of the risk situation.
A6.2 If at the level of the individual undertaking, the insurance group or the financial conglomerate the minimum requirements are not met, pursuant to §81 (2) sentence 1 and (1) sentence 2 in conjunction with §64a or pursuant to §104s VAG, the Supervisory Authority is authorised to issue orders it deems appropriate and necessary to the responsible undertakings and individuals to establish sound administrative procedures.
Principle of Proportionality
A6.3 The principle of proportionality states that the requirements must always be met taking the undertaking-specific risks, the nature and scale of the business operations as well as the complexity of the undertaking‟s business model into account. BaFin therefore assumes that the requirements set out in its Circular can be met by all undertakings.
Risks
A6.4 All risks identified by management, which can have a sustainably negative impact on the undertaking‟s financial position, performance or cash flows are considered material. In order to assess whether or not a risk should be deemed material, management must obtain an overview of the undertaking‟s overall risk profile. The definition of material risks is the result of the undertaking-specific risk identification processes, the risk analysis and risk evaluation and the scaling of materiality the undertaking applies. The undertakings must implement effective control and monitoring measures to ensure that there will be no material errors which could cause the undertaking to accept unreasonably high risks. Appropriate arrangements are to be implemented for risks that are not considered material.
A6.5 The minimum risk categories to be taken into account by the undertaking are underwriting risk, market risk, credit risk, operational risk, liquidity risk, concentration risk, strategic risk and reputational risk.
Management Responsibility
A6.6 All managers – irrespective of internal rules regarding areas of responsibility – are responsible for ensuring that the undertaking has sound administrative procedures.
Elements of Adequate Risk Management
A6.7 Risk Strategy
Determining the business strategy and the resultant adequate risk strategy lies in the non-delegatable overall responsibility of management and is to be documented by them. The risk strategy is to describe the risks resulting from the business strategy and should be designed in such a way that it dovetails smoothly with the functional risk treatment. The risk strategy must address the type of risk, the risk tolerance, the origin of the risk, the time horizon of the risk and the risk bearing capacity.
If new business areas are taken on or new capital market, insurance or reinsurance products are introduced, an evaluation of their impact on the overall risk profile must be made. The same applies to significant changes in market parameters and risk assessments. Changes in the risk strategy may be necessary if the overall risk profile changes substantially. Management is to review the business strategy as well as the risk strategy at least once each financial year. The strategies are to be reported to the undertaking‟s supervisory body for discussion.
Milliman Report
Report of the Independent Expert on the proposed transfer of the insurance business of certain of the branches of MSIEu to MSIG AG
August 23, 2013 77
A6.8 Organisational Framework
The organisational structure of the undertaking is to be geared to supporting the undertaking‟s most important strategic goals. In principle, there must be a clear separation of incompatible functions, up to and including the management level. The persons responsible for building up risk positions may not at the same time, even indirectly, be simultaneously entrusted with their monitoring and control.
An independent risk control function is responsible for identification, analysis and evaluation of risks; development of methods and processes for risk evaluation and monitoring; risk reporting; recommendation of limits; monitoring limits and risks at an aggregate level; assessing planned strategies under risk aspects; evaluating new products as well as the current product portfolio in terms of risk; validating risk evaluations performed by business units.
The operating business units are responsible for implementing the identification, analysis and, in particular, the treatment of all material risks in their area. The business units are free to subdivide the limits specified for them by management. The tasks, responsibilities, representation rules and competencies of the business unit when dealing with risks are to be defined and documented.
The internal audit function independently reviews all business units, processes, procedures and systems following their own procedure and objectively focusing on risk. In this way, it is able to detect risks, hazards and deficiencies at an early stage and report them to management. The guidance states that the requirements must always be met taking the undertaking-specific risks, the nature and scale of the business operations as well as the complexity of the undertaking‟s business model into account. BaFin therefore assumes that the requirements set out in its Circular can be met by all undertakings.
A6.9 Operational Structure
The operational structure is to support the main functions of the organisational structure in line with the risk strategy. The operational structure enables all responsibilities and all business processes that involve material risks to be determined. The operational structure is to be clearly defined. Appropriate responsibilities are to be defined for all business processes that involve material risks including the transfer of data and results.
The operational structure requires adequate personnel resources. Staffing must be based, among other things, on internal requirements, business activities and the risk situation. Employees must be trained so that they can identify risks and address them appropriately.
All business processes dealing with operations that involve material risks are to be adequately managed and monitored. Such business processes include, at a minimum, the underwriting business, provisioning, investment management (including asset liability management) and ceded reinsurance management.
A6.10 Risk Bearing Capacity Concept and Limiting
Based on the undertaking-specific overall risk, a risk-bearing capacity concept is to be prepared, which sets out the risk taking potential (i.e. the total capital available to cover potential losses or any other item able to absorb potential losses) and how much of this risk-taking potential is to be used for the coverage of all material risks the undertaking has taken on. Compliance with the regulatory capital adequacy requirements constitutes the lower limit for the required risk-bearing capacity. Moreover, undertakings must examine whether the regulatory required capital resources are sufficient to address their current overall risk and their strategic goals.
Based on risk-bearing capacity, a consistent system of risk limits is to be installed, which breaks down the risk limits set by management in line with the limits defined in the risk strategy into the undertaking‟s most important managing organisational units.
Milliman Report
Report of the Independent Expert on the proposed transfer of the insurance business of certain of the branches of MSIEu to MSIG AG
August 23, 2013 78
A6.11 Risk Control Process
Risk identification. All risks are to be consistently defined by the undertaking and to be recorded and classified throughout the undertaking (i.e. in all operational processes and at all functional and hierarchical levels) in a structured, timely and systematic manner. Risk identification must be conducted in all of the undertaking‟s business units.
Risk analysis and evaluation. Building on the results of the risk identification, the undertaking shall analyse and evaluate the risks. Risk analysis and evaluation must lead to a qualitative and quantitative assessment of potential and actual slippage from targets owing to individual risks, as well as to the overall risk.
Risk treatment refers to risk handling measures. Risk treatment thus comprises the process of developing and implementing strategies and concepts aimed at either deliberately accepting, or avoiding or limiting identified and analysed risks. Risk treatment based on the risk strategy is performed by the business units which have profit & loss responsibility.
Risk Monitoring requires monitoring of all risks that have been identified and includes control of risk profile, limits, implementation of the risk strategy, risk-bearing capacity, risk-relevant methods and procedures, and risk-handling. Risk monitoring must occur regularly and should be based on the individual overall risk profile of an undertaking as well as on the frequency and type of changes in the business environment.
Risk Culture and Communication. Undertakings must ensure adequate internal communication of all material risks. This is the responsibility of management and the managerial staff and requires an adequate risk culture within the undertaking, which heightens the risk awareness of all employees involved with risks, creates sufficient risk transparency and promotes internal dialogue on risk management issues.
Risk reporting. All undertakings must have a meaningful risk reporting system in accordance with the provisions of section 64a (1) sentence 4 no. 3d) VAG. Regular risk reporting must be performed at least once a year.
A6.12 Quality Assurance, Internal Risk Treatment and Control System
The data, models and procedures applied in the internal risk treatment and control system and any necessary modifications are to be validated and documented systematically and in a manner that is transparent for knowledgeable third parties. Each undertaking must individually define and approve its validation process. The validation process is to demonstrate the ongoing usefulness, adequacy, quality, completeness and validity of the data, models and procedures applied.
A6.13 Internal Auditing
Every undertaking must have an operational internal audit function as an essential component of sound administrative procedures.
The internal audit must refer to all significant administrative procedures, particularly also risk management activities. The activities of the internal audit function must be based on a comprehensive audit plan which it shall update on a yearly basis. Audit planning must be risk-oriented. Audit planning, audit methods and quality must be reviewed and developed further on an ongoing basis. Audit planning, as well as any major adjustments to it, must be approved by management.
The internal audit function must perform its duties in an objective and independent manner. Moreover, it must have sufficient and appropriately qualified personnel. In order to enable it to perform its duties, the internal audit function must be granted a full, unlimited right to information and auditing.
A6.14 Outsourcing of Functions and Services
The partial or complete outsourcing of functions or services may only be undertaken in accordance with the principles set forth in §64a (4) VAG.
On the basis of a risk analysis, the undertaking shall determine on its own responsibility what activities and processes are suitable for outsourcing from a risk point of view. This shall be the basis for an undertaking‟s decisions on outsourcing. Within the framework of its duties, the internal audit function must also be involved.
Milliman Report
Report of the Independent Expert on the proposed transfer of the insurance business of certain of the branches of MSIEu to MSIG AG
August 23, 2013 79
A6.15 Contingency Planning
Undertakings must prepare for disturbances and for emergency and crisis situations (contingency planning), when continuity of the most important processes and systems is no longer ensured and normal organisational/decision-making structures are no longer sufficient to deal with them.
Contingency plans are to be regularly reviewed for effectiveness and suitability and must be made available to the business units involved.
Source: MaRisk VA