The Solvency II Directive 2009EC is an EU
Directive that codifies and harmonises the EU insurance regulation. Primarily this concerns the amount of capital
that EU insurance companies must hold to reduce the risk of insolvency. Following an EU Parliament vote on the Omnibus
II Directive on 11 March 2014, Solvency II is scheduled to come into effect on 1 January
2016. This date has been previously pushed back
many times. Aims
EU insurance legislation aims to unify a single EU insurance market and enhance consumer protection. The third-generation Insurance Directives
established an “EU passport” for insurers to operate in all member states if they fulfilled
EU conditions. Many member states concluded the EU minima
were not enough, and took up their own reforms, which still lead to differing regulations,
hampering the goal of a single market. Political Implications of Solvency II
Solvency II is a major political issue in the UK which may affect how the country votes
should a referendum on EU membership take place in the coming years. A number of the large Life Insurers in the
UK are extremely unhappy with the way the legislation has been developed. In particular concerns have been very publicly
expressed over a number of years by the CEO of Prudential, the UK’s largest Life Insurance
company. Doubts about the basis of the Solvency II
legislation, in particular the enforcement of a market-consistent risk model have also
been expressed by American subsidiaries of UK parents – the impact of the ‘equivalency’
requirements are not well understood and there is some concern that the legislation could
lead to overseas subsidiaries becoming uncompetitive with the local peers, resulting on the need
to sell them off, potentially resulting in a ‘Fortress Europe’. Background
Since the initial Solvency I Directive 73EEC was introduced in 1973, more elaborate risk
management systems developed. Solvency II reflects new risk management practices
to define required capital and manage risk. While the “Solvency I” Directive was aimed
at revising and updating the current EU Solvency regime, Solvency II has a much wider scope. A solvency capital requirement may have the
following purposes: To reduce the risk that an insurer would be
unable to meet claims; To reduce the losses suffered by policyholders
in the event that a firm is unable to meet all claims fully;
To provide early warning to supervisors so that they can intervene promptly if capital
falls below the required level; and To promote confidence in the financial stability
of the insurance sector Often called “Basel for insurers,” Solvency
II is somewhat similar to the banking regulations of Basel II. For example, the proposed Solvency II framework
has three main areas: Pillar 1 consists of the quantitative requirements. Pillar 2 sets out requirements for the governance
and risk management of insurers, as well as for the effective supervision of insurers. Pillar 3 focuses on disclosure and transparency
requirements. Contents
Title I General rules on the taking-up and pursuit of direct insurance and reinsurance
activities Chapter I Subject matter, scope and definitions
Chapter II Taking-up of business Chapter III Supervisory authorities and general
rules Chapter IV Conditions governing business
Chapter V Pursuit of life and non-life insurance activity
Chapter VI Rules relating to the valuation of assets and liabilities, technical provisions,
own funds, solvency capital requirement, minimum capital requirement and investment rules
Chapter VII Insurance and reinsurance undertakings in difficulty or in an irregular situation
Chapter VIII Right of establishment and freedom to provide services
Chapter IX Branches established within the community and belonging to insurance or reinsurance
undertakings with head offices situated outside the community
Chapter X Subsidiaries of insurance and reinsurance undertakings governed by the laws of a third
country and acquisitions of holdings by such undertakings
Title II Specific provisions for insurance and reinsurance
Title III Supervision of insurance and reinsurance undertakings in a group
Title IV Reorganisation and winding-up of insurance undertakings
Pillar 1 The pillar 1 framework set out qualitative
and quantitative requirements for calculation of technical provisions and Solvency Capital
Requirement using either a standard formula given by the regulators or an internal model
developed by theinsurance company. Technical provisions comprise two components:
the best estimate of the liabilities plus a risk margin. Technical provisions are intended to represent
the current amount theinsurance company would have to pay for an immediate transfer of its
obligations to a third party. The SCR is the capital required to ensure
that theinsurance company will be able to meet its obligations over the next 12 months
with a probability of at least 99.5%. In addition to the SCR capital a Minimum capital
requirement must be calculated which represents the threshold below which the national supervisor
would intervene. The MCR is intended to correspond to an 85%
probability of adequacy over a one year period and is bounded between 25% and 45% of the
SCR. For supervisory purposes, the SCR and MCR
can be regarded as “soft” and “hard” floors respectively. That is, a regulatory ladder of intervention
applies once the capital holding of theinsurance undertaking falls below the SCR, with the
intervention becoming progressively more intense as the capital holding approaches the MCR. The Solvency II Directive provides regional
supervisors with a number of discretions to address breaches of the MCR, including the
withdrawal of authorisation from selling new business and the winding up of the company. Criticisms
Think-tanks such as the World Pensions Council have argued that European legislators pushed
dogmatically and naively for the adoption of the Basel II and Solvency II recommendations. In essence, they forced private banks, central
banks, insurance companies and their regulators to rely more on assessments of credit risk
by private rating agencies. Thus, part of the public regulatory authority
was abdicated in favor of private rating agencies. The calibration of the standard formula for
assessing equity risk has been criticized for the fact that the procedure used for determining
correlations between different asset classes gives rise to spurious correlations or spurious
relationships. The demanding nature of Solvency II legislation
compared to current regulations has attracted criticism. According to RIMES, complying with the new
legislation will impose a complex and significant burden on many European financial organizations,
with 75% of firms in 2011 reporting that they were not in a position to comply with Pillar
II reporting requirements. See also
European company law Own Risk and Solvency Assessment
References External links
EU FAQ on Solvency II European Commission on Solvency 2
FSA on Solvency 2 Meeting the Data Quality Management Challenges
of Solvency II Solvency II may endanger retirement outcomes
for future pensioners Solvency II timeline from Deloitte
Solvency II impact on Asset Managers from Ernst & Young
Lloyd’s of London guidance