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Solvency II for Insurance

Solvency regulation for insurance companies in the EU is being fundamentally reformed. The Solvency II project will introduce a new solvency regime, based on an integrated risk approach, with provision for these risks in the form of solvency capital. Solvency II is an evolution from Solvency I, adopted in 2003.  The plans are likely to be formalised in the Solvency II directive expected to be adopted by the EU in 2007 for planned implementation in 2010. 

The objectives behind Solvency II are consumer protection for policy holders and assessing overall solvency of insurance companies using measures of solvency which better reflect the risks an insurer is exposed to. It will lead to greater harmonisation across financial sectors and harmonisation of supervisory methods across Europe. It is based on a similar approach to Basel II, introduced for the banking and securities industry in the EU. It signals a shift away from a compliance approach to an enterprise risk management (ERM) culture. Under Solvency II an insurer will have to satisfy regulators that it has risk management systems integrated in a day to day risk management process.

3 Pillar Approach

The development of Solvency II is based on a 3 Pillar Approach similar to Basel II adopted by the banking and securities industry.

Pillar 1 - Quantitative requirements (Solvency)

  • Financial data
  • Internal models
  • Expected losses

Pillar 2 - Qualitative requirements (Regulatory)

  • Risk management function
  • Assess and maintain capital

Pillar 3 – Market discipline (Disclosure & transparency)

Timeframe for Solvency II

The development of Solvency II is following a Lamfalussy type consultative process, similar to Basel II and MiFID. Although the implementation, which is currently planned for 2010, may seem a long way off there is a lot to do in the interim. The key milestones and dates are:

  • Early 2007 - First draft of Solvency II directive 
  • Spring 2007 - Quantitative Impact Study No 3 (QIS3)
  • July 2007 - Commission’s proposal for a framework directive on Solvency II
  • 2008 - Detailed implementation rules – 2008
  • 2008 - Exposure draft for IFRS on insurance contracts
  • 2008 - Understand the implications of Quantitative Impact Study 4 (QIS4)
  • 2009 - Implementation arrangements made by national regulators and insurers
  • Early 2010 - Unofficial target date for the new Solvency II regime

Solvency II in Summary

Solvency II is aimed at improving risk management across the insurance industry within the EU based on an integrated or enterprise risk management approach. Solvency II is principles, rather than rules based. Insurers will need to be able to explicitly identify risk interdependencies which will create incentives for insures to develop their own internal risk models. 

Solvency calculations will be based on market-consistent valuation of assets and liabilities. Risk based portfolio analysis is achieved by applying an integrated approach, taking into account dependencies between risk categories:

  • Minimum Capital Requirement (MCR) – below which it is an unacceptable risk to policy holders
  • Solvency Capital Requirement (SCR) – sufficient capital to absorb significant unforeseen losses and assure policy holders that payments will be paid as they become due. SCR can be by
    • Standard Approach (Model)
    • Internal Models

Need to harmonise with IASB accounting standards.

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