Under the drive of an ever-changing environment, the European Commission is about to introduce a new regulatory framework for insurance and reinsurance.
Launched in 2001, Solvency II is set to offset Solvency I limits, thus ensuring insurance corporate soundness by strengthening and simplifying prudential rules to which it is submitted.
Solvency 2: contributions to the insurance field
Approved by the European Parliament,Solvency II [4] will come into force in November 2012.
Reform is designed to:
- protect the insured and insurance policies' beneficiaries.
- simplify existent rules.
- adapt prudential rules to the markets' modernization.
- establish a regulatory framework which best reflects insurers' risks.
- assess the insurer's overall solvency.
- holding insurance companies accountable by inciting them to develop internal control models (reserve calculation methods based on actuarial principles and assets management).
- allow a double approach for the capital level required with:
- obligation to detain a minimal amount of shareholders' equity, this amount being lower than it used to be in the past.
- obligation to meet solvency margin criteria on assets and liabilities.
- bring control methods designed for banks closer to those reserved for the insurance market.
- control large groups more effectively by considering their different subsidiaries and branches.
Solvency II approach
This approach rests on three components :
Financial resources
Solvency II defines the quantitative requirements that allow the evaluation of financial resources: liabilities, investments, and shareholders' equity.- the requirements of technical provisions are based on the factors which best reflect insurers' liabilities.
- requirements regarding investments demand an evaluation of the latter at a price linked to their evaluation of the financial markets.
- the solvency requirement determines the minimum capital allowing the insurers to face an unexpected peak loss experience by taking into account the risks to which they are confronted. The solvency level may be calculated through a standard model elaborated by the supervising authority or by means of the insurer's internal models which are previously validated by the control authorities.
- the requirement of a minimum shareholders' equity defines a new safety criterion beneath which no insurer can continue to operate. When the shareholders' equity requirement is not met, the insurer is placed under trusteeship until his return to the minimum threshold. If that is not possible, then the insurer is bound for liquidation.
Control
Solvency II determines qualitative obligations thanks to the establishment of a supervision process, of internal control principles for risk management. The supervision processes are carried out at an extended scale. Indeed, apart from being common to the entire European Economic Community, these measures also provide for coordination between the supervising authority of the different states in times of crises
The supervision of insurers' risk management tools will be essential. These management tools will undergo a series of tests: use, calibration and quality tests. Eventually, the competency of the leadership teams will be considered and a special focus will be put on the diversification of risks.
Transparency
The new standards require the kind of transparency and discipline which facilitate communication and promote the market's natural mechanisms. This way, the insured as well as the investors shall benefit from all the elements to judge the soundness of a European insurer.
These communication mechanisms are based on the so-called “Bâle II” approach, (the banking system's regulatory framework) and IFRS (International Financial Reporting Standards).
Application of Solvency 2 in insurance : Conclusion
Solvency II is an ambitious European project initiated and run by the European Economic Community in close consultation with the professional institutions. Solvency II is designed to secure the elaborated insurance sector by requiring the appropriate capital and shareholders' equity levels. This project will, therefore, allow to evaluate risks incurred by insurers at any time while facilitating transparency and communication.
The good performance of Solvency II is based, however, on insurers themselves who are required to provide the control authorities with the necessary data that will be useful to their own analyses. The preparation, development and documentation necessary to each company for the establishment of Solvency II represent a hard and important work especially for the insurers who intend to use their own models. Solvency II implementation costs are consequently not negligible considering the current financial crisis.