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Last week the European Commission released its 367-page proposal for the Level 1 version of the new Solvency II Directive for insurance and reinsurance firms, together with a document of 44 FAQs. The proposal now passes to the European Parliament and Council for consideration.
However, much still remains to be done, as the proposal is under the Lamfalussy process, meaning that this document simply contains the high level principles of Solvency II and will be followed by a Level 2 technical document with detailed implementation rules. In addition, there are the Quantitative Impact Studies (QIS) which will test the various capital models against real-world scenarios and confirm their quantitative impact. Three QIS have been run to date, QIS 3 results are published in November, with a fourth expected in 2008. It will be 2012, at the earliest, before Solvency II is operational.
To date, insurers have only had to allow for insurance risk in demonstrating their financial soundness. In future they will have to hold capital also against market risk (e.g. a fall in the value of an insurer's investments), credit risk (e.g. when debt obligations are not met) and operational risk (e.g. malpractice or system failure). All these risk types pose material threats to insurers' solvency but are not covered by the current regulations. They would need to assess their capital needs in light of all risks by means of the 'Own Risk and Solvency Assessment', while the 'Supervisory Review Process' would shift supervisors' focus from compliance monitoring and capital to evaluating insurers' risk profiles and the quality of their risk management and governance systems. In addition, cross-border insurance groups would have a dedicated 'group supervisor' that would enable better monitoring of the group as a whole.
The EC's Internal Market and Services Commissioner, Charlie McCreevy, said: "This is an ambitious proposal that will completely overhaul the way we ensure the financial soundness of our insurers. We are setting a world-leading standard that requires insurers to focus on managing all the risks they face and enables them to operate much more efficiently. It's good news for consumers, for the insurance industry and for the EU economy as a whole."
However there is much yet to do and many issues are uncertain. Insurance companies will be lobbying hard over detailed implementing measures, the approval of the quantitative models, and will be seeking clarity on how national regulators across Europe will put Solvency II regulations into practice. The EU's Capital Requirements Directive (Basel II) managed to move fairly smoothly through these areas, although Cross-border supervision still has to be nailed down. MiFID has been, and still is a challenge. Will these directives provide beneficial experience for Solvency II?
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