The current regime « Solvency I » dates from 1973. The main criticisms addressed to it are the lack of proportionality and sensitivity to risk. In addition, the lack of convergence of practices does not facilitate the supervision process by the authorities at the European level. To address these shortcomings, a new regulatory framework called « Solvency II » is currently under development and its basic principles have been outlined.
The legislative process began in 2009 with the adoption of the European Directive by the European Parliament on April 22nd, 2009 and approved by the Commission on May, 5th 2009 and which will soon be amended by the Directive « Omnibus 2″.
The « level-2″ measures are currently being drafted and expected shortly. The « level-3″ measures and technical standards will be produced by EIOPA before transmission to the European Commission towards the end of the year.
A new Directive, the so-called « Omnibus 2″ Directive, should be adopted by the European Parliament in the first half of 2012. Its purpose is to amend Solvency II. It defers by one year the implementation of the reform, from 1 January 2013 to 1 January 2014. Furthermore, the implementation of these measures is currently under development by the different European institutions (Commission, Parliament and Council). They should be adopted in the second half of 2012.
The requirements
The requirements are structured around three pillars as follows:
- Pillar 1: quantitative requirements
- Pillar 2: risk management
- Pillar 3: reporting requirements
These pillars are supplemented by a fourth aspect that is the highly innovative group control.
The new prudential framework is based on a comprehensive approach to different risks.
The quantitative requirements which constitute the first pillar address:
- The calculation method of technical reserves
- The prudential assessment of other balance sheet items
- The definition of shareholders’ funds
- The determination of the Solvency Capital Required (« SCR »).
The pillar 2 introduces the concept of « system of governance » whose objective is to ensure a sound, prudent and efficient management of operations.
This system of governance is based on the three following components:
- A transparent and adequate organizational structure
- A clear allocation and appropriate separation of responsibilities
- An efficient mechanism for the transmission of information.
The pillar 2 also introduces ORSA (« Own Risk and Solvency Assessment »), which corresponds to an internal assessment of risks and solvency levels (Article 45 of the 2009/138/EC Directive).
ORSA is a proprietary analysis process that should be part of strategic decisions made by the Insurance company. It consists of a regular assessment of both short term and long term consolidated solvency requirements reflecting the company’s strategy and risk appetite. The objective is to continuously meet Pillar 1 requirements (SCR, MCR and technical reserves) and to identify any changes in the risk profile relative to the underlying assumptions.
The pillar 3 consists of:
- A fixed frequency reporting:
- An ad-hoc reporting when predefined events occur (Art. 35 (2) (a) (ii) and Article 53 (1))
- On-request reportings when investigations are conducted on the financial condition of a given Insurance or Reinsurance company (Art. 35 (2) (a) (iii)).
-Information to be provided for control purposes (Art 35.1)
-Public disclosure « Report on solvency and financial condition » (Art. 50)
Solvency II challenges:
- To strengthen insurers’ creditworthiness and policyholders’ safety, and therefore the stability of the European financial system under normal as well as under stressed conditions
- To set up more consistent and predictable standards, Europe-wide
- To contribute to the modernization and competitiveness of the European insurance sector.
Focus on QIS 5:
The release of QIS 5 results in March 2011 is an important milestone in the process of drafting new regulations. The participation rate of French insurance firms to QIS5 stands at 70%. This new regulation will allow the harmonization of prudential regimes that apply to the insurance sector at the European Union level. It will also help to improve risk management practices.
The take-up of results of the fifth quantitative impact study was completed in November 2010. It is particularly important for all actors, since it provides a measure of the quantitative impacts that will drive the final adjustments in terms of calibration.
The impact study helped to understand the market readiness for Solvency II. It served as an opportunity for Insurance and Reinsurance companies to test their operational processes’ soundness and to share knowledge of future regulations among their colleagues.
Our beliefs:
- Avoid organizations in silos and choose organizations that favor information sharing between Risk Management, Internal Control, Audit and Actuaries teams;
- Do not ignore the importance of Governance which plays a leading role in Risk Management (strategic risk, reputation risk, etc.)
- Industrialize as soon as possible the data collection and data quality management processes to properly assess the risk profile
- Incorporate qualitative governance in your internal model projects
- Incorporate the Risk function when drafting your risk scenario analysis
- Do not underestimate the importance of tail risks in your assessment of capital
- Involve your colleagues that form the scheme’s cornerstone and provide them with a clear and accurate documentation.
