Solvency II: pain versus gain

The Solvency II regime, a European Union directive that aims to codify and harmonise EU insurance regulation – and echoes Basel II in outlining the minimum levels of capital that insurers must hold – is finally introduced this month.

Solvency II was devised to protect policyholders and therefore to guarantee a long-term horizon of solvency. Among the expected impacts will be that the weaker insurance companies will either merge or leave the market. The measures have attracted much controversy, being opposed by many companies in the sector and have undergone various revisions with the launch put back several years.

So is the final set of rules fit for purpose?

This is a very leading question. The harmonising of an insurance regulatory regime across Europe always was – and has indeed proved to be – an extremely complex undertaking with numerous stakeholders needing to be engaged.

Quite rightly the implementation was delayed, with a limited number of jurisdictions implementing “shadow regulations” such as in France. The extra time permitted review of how the regulation was to work in real life and for any questions of clarity to be answered.

The result from the jurisdictions that implemented the shadow regulations allowed for a fine-tuning of the regulations. Local variances were required to reflect local sales practices. One example of this is the grandfathering of guaranteed annuity policies in Germany, which were sold at a time of higher interest rates – and thus more favourable investment returns – than now. Over time, though, convergence across Europe will occur.

Reporting

Already we have seen the impact of Solvency II in terms of reporting. An example of this has been instances where investment managers have not been able to comply with reporting requirements. As a result, we have seen mandates being moved to investment managers who are more willing to provide these data points.

Transparency has meant that insurance companies are able to scrutinise investments as never before. This has seen a level of investment expertise which did not previously exist in insurance companies being acquired. This scrutiny has helped insurance risk departments understand more of the investment risk.

Investments

With the levels of transparency, insurance companies have been able to ensure that investments are in the most efficient form in terms of capital usage. We have seen insurance companies rebalancing their portfolios to this effect already. We are also seeing a more active management of these assets; another positive development as there is a deeper understanding of investment risk developing within insurance.

Process

The framework of the Solvency II regime consists of three pillars. Pillar II requires disclosure on the company’s internal polices, how these are carried out and the oversight in place to ensure adherence. Again, this requirement has reinforced process and procedures ensuing full documentation and oversight for adherence.

So to return to the question “Is the final set of rules fit for purpose?” on balance the answer must be a “yes”. As noted above, bringing together numerous local requirements under one regulatory regime was always going to prove difficult, but overall the balance has been struck between local and pan-European requirements and with finite time allowed for convergence.

Most importantly, the regulation is not fixed but will have continuous updates. As such, the regulation will not become stale and will be able to adjust to both investment and market conditions.

Several national regulators affirm that companies’ data will not be clear and reliable for at least a couple more years. From their point of view there is, in any case, the need to let the process begin.

Time will tell how effective Solvency II will be, but if markets such as France are a good indication we will see fewer, but larger insurance companies. Many of the smaller ones will have either merged or decided to close their doors. The costs of running an insurance company will increase, but the overall transparency that the new regulatory regime brings will more than compensate.

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