Insurers must start planning now to implement Solvency II by 2012, with the legislation almost on the statute book. It is expected to provide a global benchmark for insurance regulation. But with provision for multinational groups removed, will it still meet industry needs?
AS THE GLOBAL economy has shifted seismically over the past 12 months, Solvency II, the new regulatory framework for insurers across Europe, has inevitably come under the spotlight.
Earlier this month, Brussels rubber-stamped the legislation in its final form, following protracted squabbles that nearly sent the whole thing back to the drawing board. But there was much dismay that a key plank of the legislation had to be removed for agreement to be reached.
Following pressure from member states including Spain, France and Poland, there will not now be provision for group support, which would have allowed multinational insurers to be regulated by a lead supervisor in their home state, rather than separate supervisors in each state of operation.
So is this the end of Solvency II as we knew it, or will the new legislation still achieve its goals?
We asked four of the major players to outline their views on the final form of the most important legislation in a generation.
The consultant: there’s no time to waste
Martin Bradley, Ernst & Young Solvency II task force
A delay into 2013 might have given insurers more time to prepare for implementation. With implementation on 31 October 2012 now confirmed, there is no slack in anyone’s timetable.
Look at the recent scheduling from the FSA and the expectation that insurers will start dry-running internal models and sharing their outputs with the supervisor as early as June next year. Lloyd’s also has been busy communicating demanding schedules to managing agents. Since it requires syndicates to model projected capital for the next underwriting year, players in the Lloyd’s market will require Solvency II compliance by mid-2012, earlier than the company market.
It’s a tribute to both the architects of Solvency II and its current day handlers that the directive will not only pass into law, but that the framework of principles on which it’s based is undamaged, in almost every respect. This is no mean feat given that, quite serendipitously, the directive’s final passage has coincided dramatically with a sudden shattering of global confidence.
The spotlight has been on supervisors and the rules governing the supervision of financial institutions. Clearly there has been a strong emphasis on banking but there easily could have been rash changes or severe delays to Solvency II, which thankfully have been avoided.
The erasure of the support regime for insurance is not a major issue, but regulators must develop this component for their future rulebook so that the reliability of intra-group capital transfers can be demonstrated by insurers and rigorously challenged by supervisors. This may happen by 2015 since the directive requires an ongoing review of the effectiveness of supervision of insurance groups. ‘
In the meantime there is much that insurance groups need to do to prepare themselves for group-level supervision before the end of 2012. Groups will be expected to have identified a lead supervisor in Europe; that supervisor’s actions will have an impact across group risk management frameworks, group internal models and group model approval.
Whether a firm is a solo entity or part of a group, all now face the same question: “How can we organise ourselves to be ready on time?”
Most have started with a gap analysis. The FSA and, in turn, Lloyd’s, have sent strong signals that they want to see gap analyses leading to detailed implementation planning.
Indeed supervisors go further and insist on two separate plans. The first stage identifies the overall Solvency II implementation planning requirements across a wide base to cover governance, processes, roles and responsibilities – essentially all aspects of running the insurance portfolio. A second, lower level, plan covers the iterative development of the internal model driving the Solvency II capital assessment.
The trade body: an overview
Paul Barrett, assistant director of financial regulation, ABI
The next generation of insurance rules has been established, at least in outline, and given the interest around the globe it may well be that a template for many other jurisdictions has been produced as well.
At a time of uncertainty in the global economy, agreement on a next-generation standard for insurance is a positive development.
We are, however, disappointed that an opportunity has been missed to enhance the regulation of groups that operate across borders. The fact that capital requirements will still be applied separately in each country a firm operates in, not managed centrally by its lead supervisor, is a missed opportunity. As the De Larosière report outlined last month, we need supervision that reflects the cross-border nature of businesses.
However, we must remember that Solvency II has a review clause covering group capital, and it is therefore possible that full group capital management will come into existence in a few years anyway. The important thing is that we are heading in the right direction.
The current financial crisis demonstrates the importance of well-based prudential requirements and high standards of regulatory supervision. Solvency II will ensure that the risk-based approach adopted in the UK will now be applied across the EU.
Insurers are weathering this crisis, supported by good risk management and a sophisticated regime for capital that relies on hard analysis, not crude ratios topped up by a bit of cash to meet the unexpected.
The broader political framework, with De Larosière in Brussels and [the FSA Turner Review and discussion paper] in London, point towards re-enforcing the unfinished agenda on groups that the directive has started. There is growing support, even in the UK, for new European institutions to oversee and manage national supervisors across financial services – mirroring attempts by President Obama to create a more rational and modern framework for the regulation of US financial institutions.
The insurer: the implementation
Jean Drouffe, finance director, AXA
Following some rather prolonged negotiations between the European Parliament, Commission and Council, the level one framework directive now seems to be in the bag. In many ways that political phase was the most difficult and unpredictable part of the process and now we are really en route for an implementation by the end of 2012.
For the industry and the policyholders, the adoption of Solvency II really represents a step forward: of course it is a compromise and some key elements have been dropped, but the essence of the original idea is still there, namely an economic prudential framework.
This risk-sensitive approach will allow us to create a full alignment between effective capital management and the interests of the policyholder. No longer will there be benefits to inadequate management actions, the sole aim of which is to arbitrage obsolete and heterogeneous solvency rules. Only the right management actions, targeting real risk reductions, will now result in reduced capital needs.
One major success is the agreement on an “equity dampener”, meaning that the degree of stress on equity assets will depend on where we are in the cycle: at the top of the market the stress applied to stock holdings will be higher than where the markets are low. This should lead to more stability in solvency assessments, reducing the need for fire sales which are currently feeding down markets.
One disappointment is the removal of the group support regime provisions. This will mean that a full effective alignment in the supervision will not be reached and the group supervisor will not have the last say to endorse a number of decisions (such as potential capital add-ons).
All in all, the directive text is positive and will trigger the right responses in the industry. Of course it will also introduce extra complexity, through internal risk modelling becoming the ultimate panacea. We will have to be careful about understanding these models and making sure they don’t become too complex and out of control (and the regulator will remind us of this). In the UK, we have a clear advantage with our experience of the FSA’s Individual Capital Assessment Standards (ICAS) system over the past five years and the credibility of the FSA as regulator.
The international market: harmonisation
Sean McGovern, Lloyd’s director & general counsel
Solvency II’s implementation will mean that EU insurers are subject to a sophisticated, risk-oriented supervisory framework that sets a standard for regulatory regimes worldwide.
It is widely recognised that the existing regulatory system is no longer adequate. This perception has not only prompted the development of Solvency II, it has also instigated the implementation by some EU member states of more rigorous capital setting and supervisory regimes, such as the ICAS system. Such arrangements recognise the desirability of a more risk-based approach to capital setting and have influenced the development of Solvency II. Solvency II’s harmonisation of regulation will help to facilitate supervisory cooperation, making it easier to address problems, especially those with cross-border implications.
Solvency II’s implementation within the Lloyd’s market is a key priority for managing agents, and for Lloyd’s centrally. Experience of ICAS will facilitate this. But Solvency II goes some way further, particularly in areas such as governance, risk management and internal controls. The numerous detailed implementation measures currently being worked on by the Committee of European Insurance and Occupational Pensions (CEIOPS) are a particular challenge.
Lloyd’s underwriters transact business around the world, so Lloyd’s is interested in the global regulatory picture. Solvency II is not just significant in Europe: it is important worldwide. As a modern, state-of-the-art system, it will be a benchmark for insurance supervision across the world.
Its approach of requiring insurers to align their capital with risk is close to the position of the International Association of Insurance Supervisors, and is influencing proposals by several non-European jurisdictions to reform insurance supervision. This will help to drive greater international convergence in the current crisis– a key theme emerging from groups such as the G20 – and assist the removal of trade barriers resulting from disparate regulatory systems.
The removal of group support provisions reduces the interest of international insurance groups in these arrangements, but does not affect Lloyd’s, which does not trade in the EU via subsidiary companies.
The financial crisis has prompted re-consideration of global financial regulation. Although the crisis arose in banking rather than in insurance, some proposals for regulatory reform have not recognised the significant differences between the two sectors. There is a danger of the unthinking application of solutions appropriate for banking to insurance, requiring insurers to operate in inappropriate regulatory environments that impose costly burdens and restrict insurers’ abilities to trade. Solvency II is important as a safeguard from this unattractive scenario.
Its implementation on schedule in 2012 will ensure that the European insurance industry and its customers benefit from a sensible supervisory framework, carefully designed to protect policyholders and to ensure the sector’s long-term prosperity. IT