| Solvency II: Insurance companies need to gear up |
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| 01/10/2006 | |
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Insurance companies should not wait any longer to integrate the Solvency II prudential norm in their processes, even if the directive's likely implementation date in EU Member states is set for 2010. "The solvency pressure on insurers is stepping up as the schedule runs down," says Jean-Charles Guéganou, Ernst & Young's Solvency II coordinator for Continental Europe. "Insurers have to develop their internal model, enhance their risk management systems as well as their information technology systems while bringing their executive up to Solvency II speed." The objective of Solvency II is to establish a solvency measurement framework that will take into account the real risks faced by insurers as well as a larger series of qualitative criteria. Ultimately, the capital asset allocation will be modified so as to fit those risks. The current norm (Solvency I), implemented in most EU Member states' national legislation in 2002, is based on a set of quantitative criteria that does not properly measure the risks faced by insurers. This can lead to large differences between the regulatory capital and the economic capital used to run an insurance business. Even though the Lamfalussy process is still in its early stage, it has already been suggested that insurers with the heaviest equity investments would likely have to raise their capital. Most insurers have tried to convince the Committee of European Insurance and Occupational Pensions Supervisors (CEIOPS), involved in the process, to limit such consequences, while applauding the possibility to step up the use of hybrid capital under the new norm. The Solvency II capital will include the operational risks faced by insurers, who will have to publish two types of minimum capital requirements: the minimum level of regulatory capital (MCR - Minimum Capital Requirement) and the risk-based level of regulatory capital (Solvency Capital Requirement – SCR). The standard model to be used to set the level of risk-based regulatory capital has yet to be defined. So far, European insurer organisations have told the CEIOPS that their standard model proposal would penalise equity holders too strongly. Banking on past experience For insurers starting from scratch, the implementation workload will be a tremendous task, and is likely to be the bread and butter of consultants for the years to come. Luckily enough for them, they can also take lessons from the Basel II experience, the prudential norm for the banking industry. "The three pillars of Solvency II are about the same as for Basel II," points out Marie-Laure Delarue, Basel II project specialist at Ernst & Young. She draws a parallel between the prudential ratio that will stem from the Solvency II norm and the McDonough ratio, which is now used in banking institutions. The old banking prudential ratio, the Cooke ratio, did not take into account the operational risk. "It was a norm of prudential management which did not depend on the individual risk profile of each and every bank," she says. As of now, the European Commission is still at the first stage of the directive process, which could be first published as a project in March 2007, followed by its adoption by the European Parliament. Level 2 (general measures) and 3 (detailed measures) should then follow with the implementation into national legislation planned for 2010, depending on the delays. However, insurers should not wait before getting up to speed. "The system needs to have been tested a couple of years before," says Ms Delarue. "With Basle II, banks have gone through some hardships when implementing their new systems and models, which have often led to budgets being overrun. If insurers identify the main implementation issues now and if they take the necessary measures to put into place a proper risk management system, they will get benefits sooner from those unavoidable costs." J.L. |
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