Solvency II: EU to take global lead in insurance regulation

"EU to take global lead in insurance regulation" - With this headline, in July 2007, the European Commission published a proposal for a new regulatory framework called Solvency II. The new framework represents the most significant change in many years to the laws governing insurance and reinsurance companies in the European Union. Solvency II is designed to improve consumer protection, modernise supervision, deepen market integration and increase the international competitiveness of European insurers.

Under Solvency II, insurers will be required to consider all types of risk to which they are exposed and to manage those risks more effectively. The new system introduces more sophisticated solvency requirements to help ensure that insurers have sufficient capital to withstand adverse events. Currently, EU solvency requirements only cover insurance risks; in future insurers will be required to hold capital also against market risk, credit risk and operational risk – risk types not covered by the current EU system.

The Commission aims to have the new system in operation by 2012. The proposal is currently being reviewed by the European Parliament and Council. Approval by both entities is required for adoption of Solvency II as European law.

Why is there a need for Solvency II?

EU solvency rules help to ensure that insurance undertakings are financially sound and can withstand adverse events, in order to protect policyholders and the stability of the financial system. However, the current EU solvency system is over 30 years old and financial markets have since developed dramatically. This has resulted in a discrepancy between the reality of the insurance business today and its regulation. Also, many countries have introduced their own rules at national level, leading to a range of different regulatory requirements across the EU. 'Solvency II' aims to introduce greater harmonisation between Member States, a more level playing field for insurers and a  more uniform level of consumer protection.

What are the main aspects of Solvency II?

The regulatory framework is divided into three broad areas. These areas are commonly referred to as “pillars”. This format is derived from the existing regulations for banking supervision called “Basel II”.
Content of the three pillars can be summarised as follows:

Pillar 1 - Quantitative requirements, with rules covering technical provisions, calculation of regulatory capital requirements and investment management. 

Details of the quantitative requirements are not finalised, but a key feature will be the regular calculation of two levels of capital requirements: the Minimum Capital Requirement (MCR) and the Solvency Capital Requirement (SCR). Each insurer will be required to calculate the MCR and SCR and monitor its actual capital position against the requirement.

The MCR is not the correct level of capital that companies should hold, but it will act as a safety net. If the company’s available capital falls below the MCR, the company is technically insolvent.

The SCR will be closely aligned to the risks the company faces providing policyholders reasonable assurance that payments will be met as they fall due.

Pillar 2 – Qualitative requirements regarding a company’s internal controls, risk management processes and approach to supervisory review.

To comply with Pillar 2, insurers must review and, where required, modify and implement internal risk management processes incorporating the management of policies, claims, provisions and risks. Pillar 2 also stresses the importance of corporate governance and clearly defined roles and responsibilities for mamagement.

A supervisory tool will be introduced, known as the Own Risk and Solvency Assessment (ORSA). This requires every company to carry out a regular assessment of its solvency needs (over and above the regulatory requirements under Pillar 1) and its compliance with those needs, and submit the results to the supervisor.

The supervisor will review and evaluate both the qualitative and quantitative requirements of the company in its operating environment and the risks it does or may face. The review will be carried out regularly, with the frequency and scope determined by the supervisor, probably on the basis of its own risk assessment of the company.

Pillar 3 – Disclosure requirements – disclosures that a company will have to make publicly and to supervisors in order to provide better insight into the actual risk and return profile of the company

As part of the public disclosure requirement, companies will be required to publish an annual Report on Solvency and Financial Condition. This should include descriptions of the business and its performance, the governance system and risk exposure and mitigation.

Pillar 1 capital requirements should capture and quantify all material risks on the balance sheet. Pillar 2 will supplement Pillar 1 and promote good corporate risk management. Pillar 3 completes the framework by enhancing market discipline and a risk dialogue among stakeholders.

What is the timeline for implementation of Solvency II?

While the Framework Directive has been issued and is expected to be adopted in the near future the document is relatively general and details are not finalised.

To assist in the formulation of the details, the Commission has mandated the Committee of European Insurance and Occupational Pensions Supervisors (CEIOPS) to provide technical advice. CEIOPS is currently working on more detailed and practical guidance on calculation methods, valuation standards and other technical aspects. These details are called ‘implementing measures”.

In addition CEIOPS is organising a series of Quantitative Impact Studies (QIS) to provide insight into the possible quantitative impacts of the new solvency standard on individual companies and the industry as a whole. The results of the studies are being used in the formulation of final rules. ICISA has been involved in this process and provided comments on QIS4 specifications in 2008.

Tentative milestones along the road to implementation include:

What are the next steps for ICISA?

In addition to involvement in QIS4, ICISA is involved externally in industry discussions and interaction with supervisors to ensure that Solvency II incorporates relevant aspects of the management of credit insurance and suretyship. The ICISA Solvency II Expert Group provides a forum in which industry participants maintain awareness of regulatory developments and exchange ideas on issues of relevance to our line of business.

Main abbreviations

ACAM               Autor ité de contrôle des Assurances et Mutuelles
BaFin                Bundesanstalt für Finanzdienstleistungsaufsicht
CEA                 Comité European des Assurances
CEIOPS            Committee of European  Insurance and Occupational Pensions
                        Supervisors
CFO Forum       Chief Financial Officer Forum
CRO Forum       Chief Risk Officer Forum
EIOPS              European Insurance and Occupational Pensions Supervisors
FFSA                Fédé ration Française des Sociétés d’Assurances
FSA                  Financial Services Authorities
GDV                 Gesamtverbandes der Deutschen Versicherungswirtschaft
UNESPA           Unión Española de Entidades Aseguradoras y Reaseguradoras

Useful links

European Commission
CEIOPS
CEA
Groupe Consultatif Actuariel
International Association of Insurance Supervisors (IAIS)
International Association of Actuaries