This checklist describes Solvency II, and its aims and purpose.
Solvency II is the most up-to-date and comprehensive set of regulatory requirements for insurance companies operating within the member states of the European Union (EU). The original solvency regulations for insurers were introduced in the early 1970s and later updated under Solvency I. Since then, the principle of risk management has become an integral component of capital adequacy for insurers, and sophisticated risk management systems have been developed and implemented. The Solvency II Directive, to be introduced across the EU in 2012, replaces the existing 14 Directives and forms part of the European Commission’s Better Regulation program, which aims to simplify the regulatory environment and reduce red tape. It has been nicknamed “Basel for insurers” as it bears a number of similarities to the Basel II banking regulations.
The EU’s principle of the single market drives the rationale behind Solvency II, with the aim of introducing harmonized regulations and legislation for insurance services in the member states. Currently, insurers within the EU use the “passport” system (a single license across all member states), which is based on the concept of maximum harmonization and mutual recognition. A significant number of member states have introduced national reforms where they believe that the current minimum requirements are insufficient. This has led to a patchwork of regulatory requirements across the EU, which Solvency II aims to resolve.
Solvency II is based on economic principles for the measurement of assets and liabilities. It has a very wide scope, and consists of a comprehensive risk management framework that defines the required levels of capital adequacy, outlines procedures to identify, measure and manage levels of risk, modernizes the supervisory regime, increases the international competitiveness of European insurers, extends market integration, and improves consumer protection. Insurers will have to take account of all types of risk to which they are exposed, and manage those risks more effectively. Like Basel II, the proposed Solvency II framework consists of three main pillars.
Pillar 1 consists of the quantitative requirements for increasing financial soundness. The solvency requirements for insurers will be more sophisticated, in order to guarantee that they have sufficient capital to withstand adverse events, such as acts of God or major accidents. Current EU solvency requirements only cover insurance risks; under Solvency II, insurers will have to hold capital against market risk, credit risk, and operational risk, all of which pose material threats to insurers’ solvency.
Pillar 2 sets out requirements for the governance, risk management, and effective supervision of insurers. Insurers will be obliged to focus on the active identification, measurement, and management of risks, and to take into account all future developments, such as new business plans or the possibility of catastrophic events, that might affect their financial standing. Under Solvency II, insurers must use the “Own Risk and Solvency Assessment” to assess their capital needs in light of all risks. The “Supervisory Review Process” (SRP) will shift supervisors’ focus from compliance monitoring and capital to evaluating insurers’ risk profiles and the quality of their risk management and governance systems.
Pillar 3 focuses on disclosure and transparency requirements. Insurers will have to disclose certain information publicly. This will enforce greater market discipline, and help to ensure the stability of insurers and reinsurers. Insurance companies will also be required to report a far greater amount of information to their supervisors. Solvency II also imposes a “group supervisor” in each country that will have specific responsibilities to be exercised in close cooperation with the relevant national supervisors. The aim is to streamline supervision and ensure that groupwide risks are not overlooked. Groups should be able to operate more efficiently, while policyholders will receive a higher level of protection. Groups that are sufficiently diversified may also be allowed to reduce their capital adequacy if they meet certain conditions.