The Solvency II Directive 2009/138/EC is a European Union directive designed to update and harmonise European insurance regulation. Solvency II emerged in the wake of similar regulation of the banking sector by the Bank of International Settlement’s Basel Committee on Banking Supervision, the so-called Basel Accords. It was also sparked by the 2008 financial crisis, which turned the spotlight on risk management, capital adequacy and solvency of firms operating in the financial services sector.
In the following Q&A, Mark Westwell, senior vice president, regional client management executive, Global Services EMEA, discusses the requirements of Solvency II and the challenges it presents for insurers and their asset managers.
Q: Who is affected by Solvency II?
A: Solvency II will affect European insurance and reinsurance firms with gross premiums of more than €5 million or gross technical provisions of more than €25 million. It also applies to their branch operations in non-EU countries and may apply to their non-EU subsidiary and associated companies. Insurance groups will need to apply Solvency II calculations to their non-EU businesses unless the subsidiary is in a jurisdiction whose regulatory regime has been certified by the EU as equivalent to Solvency II. The directive has wider implications. Non-EU groups will need to submit Solvency II filings for their EU operations, although there’s no need to report their global solvency figures on a Solvency II basis. The impact on asset managers will arise from the need to provide insurance clients with the asset data they require to make the calculations stipulated by Solvency II.
Q: What will affected firms be required to do to comply with Solvency II?
A: Firms will be required to calculate and report their solvency positions to their local regulator in a fundamentally different way than they have before. Under the new regime, they must calculate their solvency position based on a standard set of calculations, unless they can demonstrate to regulators that they have an “internal model” that better reflects the risk in their business. They will also need to demonstrate effective governance and management in respect of all of the asset data used in calculating their solvency position. Over the years, insurance companies have become very proficient in gathering liability data, and they have focused their resources and investment in technology accordingly. Given the increased need under Solvency II for quality asset data and the governance surrounding it, they may find that they have an increased dependency on manual intervention. As a result, many insurers are considering outsourcing the consolidation and governance of all aspects of asset data.
Q: What is the “three-pillars” approach?
A: Modelled on the banking industry’s Basel II regulation, Solvency II establishes three sets of principles that govern the asset data used for reporting solvency positions.
Pillar 1 sets out the data requirements and how they are to be used in calculations. Following a quantitative approach, it incorporates two key measures, the Solvency Capital Requirement and the Minimum Capital Requirement.
Pillar 2 takes a qualitative approach that addresses the governance, internal controls and risk management that insurance businesses must have in place, and how they demonstrate their compliance to their regulator.
Pillar 3 deals with prudential reporting. It sets out how insurers across the EU should report their solvency levels to their regulator and the degree of transparency they adopt in operating their business and reporting to stakeholders such as shareholders and analysts. Pillar 3 also prescribes how granular information on assets is presented to regulators.
Q: When will firms need to be ready for Solvency II?
A: Solvency II is scheduled to come into law in all EU member states in March 2013 and be effective from January 2014. However, firms will need to be ready well in advance of these dates. Many larger insurance companies will opt for internal models to collect, process and prepare their asset and liability data for reporting. Given that they need to operate these models for 12 months prior to the effective date, internal models will, in effect, need to be in place from mid to late 2012.
Q: What are the broader implications for the insurance sector?
A: The additional protection of Solvency II will come with increased costs. An early estimate by the European Commission indicated that the cost to the European insurance sector of implementing Solvency II would be €2–3 billion over five years. For the first time, insurance firms will need to evaluate their strategic and operational risks and hold capital in proportion to those risks. The cost of Solvency II implementation, combined with additional capital requirements, may lead to restructuring and consolidation across the sector as a whole. It may also lead to reduced competition, particularly in capital intensive insurance products such as annuities.
The asset data requirements under Solvency II are far more rigorous and expansive than ever before. These demands will inevitably lead to greater ongoing operational costs that will impact profitability among insurers. Firms may need to absorb these costs, or pass them on to their clients through increased premiums. Many insurers will review their operating model to explore ways of mitigating the impact of Solvency II, including outsourced solutions for asset data provision.
Q: What are the specific challenges for asset managers?
A: To be able to complete their Solvency II calculations, insurance firms will require their asset managers to provide more granular data on investments held within portfolios. This requirement is likely to trigger demand for “look-through” capabilities whereby asset managers can provide the required information in an aggregated format that preserves the confidentiality of the underlying investment process.
State Street will publish a Vision thought leadership paper on Solvency II in February 2012 entitled “Solvency II: Tackling the Asset Data Challenge”.
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