Solvency II - Implications on Insurers April, 2013 BLOG POST
Solvency II to instill greater accountability in EU Insurance industry Solvency II is a fundamental review of the capital adequacy regime for the European insurance industry. It aims to establish a revised set of EU-wide capital requirements and risk management standards that will replace the current solvency requirements.1 Solvency II requires insurers to match assets with the risks they take; thereby affecting their risk management, corporate governance and the business written by the insurer. The predominant goal of this regime is to safeguard the interests of policyholders by preserving risk management at the centre of business practices, combine insurance regulations, and consolidate the European insurance market. Central elements of the Solvency II regime2
Pillar I (Risk Quantification and Capital Adequacy) calculations would quantify the level of risk firms face and identify the amount of capital they need to support that risk.3 Pillars II & III (Internal Control and Reporting) addresses the supervisory, reporting, risk management and disclosure requirements that the insurer will have to meet to comply with Solvency II.3 1
FSA UK: Solvency II GC Actuaries: Solvency II 3 CII UK: Solvency II - Enabling Transformation Through Regulation 2
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Impact on Insurance sector Insurers will have to demonstrate – Risk as a major criterion in the decision making process. Solvency II would introduce significant balance sheet and capital volatility through the use of Mark-to-Market approaches, and insurers must manage this volatility appropriately. Changes may be required to investment strategies, product mix and re-pricing of products may become necessary and in turn, this may result in changes to the investment activity of the business. Solvency II will cost insurers €2 billion to €3 billion initially and €500 million a year in Europe once in the rules are in place. Capital costs under Solvency II would cause nonlife insurance rates for some lines of business to go up as much as 20% and this would constrict product availability. Some insurers, particularly small and medium-sized companies, might be forced to consolidate or leave the business under the Solvency II proposal. 4 How will U.S. insurers be impacted? Solvency II and Risk-Based Capital (RBC) standard in U.S. share the same goal of shareholder protection and development of sound regulations thereby strengthening insurers. The RBC approach is evolving into a more Principles-Based Approach (PBA), as the Europe’s Solvency II develops. However, they are different in their focus as RBC calculations are solely focused on the capital adequacy and the Solvency II is focused on an enterprise-wide view of risk. The challenge remains with PBA that is how to expand in order to include credit, market, operational, and insurance risk. The U.S. insurers use a bottom up approach, setting the standards for one product group at a time, while Solvency II takes a top down approach by identifying high-level principles and a clear structural framework to monitor enterprisewide risk. U.S. based subsidiaries of European parents would be required to incorporate a large amount of the Solvency II requirements domestically such as calculating the solvency capital requirement (SCR) and minimum capital requirement (MCR), building a risk management framework, developing internal models, conducting an own risk and solvency assessment (ORSA), and meeting documentation and reporting standards – having a huge impact on the risk and capital management, data, and system requirements. On the other hand, EU based subsidiaries with a U.S. parent will need to meet Solvency II requirements with respect to those subsidiaries. Nonequivalence with Solvency II standards would mean U.S. parent companies could potentially be required to hold more capital, implement internal controls, report risk concentrations and intergroup transactions, and carry out risk and solvency assessments at a group level. Conclusion The transparency brought about by Solvency II will allow investors to differentiate between insurers that have volatile businesses (i.e. inaccurate risk calculation) and those that maintain sustainable profit stream. Reinsurers would be relative winners; whereby they would have the opportunity to provide capital to weaker players. Life insurers would be incentivized to transfer more risks to policyholders and third-party asset managers, while being able to more accurately account for the cost of guarantees, product flexibility, and investments in volatile assets. Some life insurers would reduce or abolish offering 4
Bloomberg news, News articles
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guaranteed products, while others would lower guarantees, introduce resets, or introduce higher fees for certain services in order reach an acceptable level of risk-adjusted profitability. Non-life insurers would experience lower profits for many products – forcing either price rise or stricter risk coverage requirements.
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