1. What is Solvency II?Solvency II refers to the new EU-wide harmonised solvency framework which is currently under development. For Solvency II, a three pillar architecture has been chosen analogous to Basel II.

§ Pillar 1 addresses quantitative capital requirements. Insurance companies must hold economic capital – called solvency capital. It should be sufficient to cover an annual loss in the magnitude of what could be expected once every 200 years. The solvency capital may be calculated using either a standard model prescribed by the supervisors or the insurer's own internal economic capital model. While it is expected that there will be considerable freedom allowed for the design of the internal model, such a model would need to meet several quality criteria. One important criterion is the so-called "use test", which requires insurers to demonstrate that results from the model are actually consistent with management decisions.

§ Pillar 2 addresses risk management issues. According to current proposals, insurers would need to have in place an independent risk management function appropriate to the nature, scale and complexity of their activities. They should have strategies for how to deal with all material risks and how the level of solvency capital can be maintained. Equally, emphasis is being put on the integration of risk management into management decision making.

§ Pillar 3 addresses disclosures both for the supervisors as well as to the general public. The industry is expecting that these disclosures will be far reaching and allow policy-holders and investors to form a more detailed picture on the health of the company. One of the key objectives of Solvency II is to enhance market discipline through disclosures.


2. What impact could it have on pension schemes and the pension fund industry?

The proposed Solvency II directive applies to all life and non-life insurance undertakings as well as reinsurance undertakings. The management of group pension funds which are currently supervised by insurance authorities will also fall under Solvency II, if certain conditions are satisfied. However, pension funds which are covered by the Occupational Pension Funds Directive will not fall under Solvency II.

The European Commission has communicated that the Occupational Pension Funds Directive and solvency requirements for pension funds will be reviewed in 2008. The EFRP (European Federation of Retirement Provision) and Directors of capitalized pension funds have expressed concern that Solvency II for pension funds may not adequately address typical features of pension funds. An example cited by one Director is the right to adjust the contribution rate if this becomes economically necessary for the pension fund.

3. Can you describe the Solvency II process and its current status?

The introduction of Solvency II follows a "Lamfalussy process". As the European Commission describes it, this means that the Solvency II directive will focus primarily on basic principles and political choices. The European Commission will then introduce more detailed and technical rules in the form of "Implementing Measures" at a later stage.

CEIOPS (Committee of European Insurance and Occupational Pensions Supervisors), which is composed of the insurance supervisors of the EU member states, is acting as an advisor to the European Commission. They have published a wealth of thoughts and proposals on Solvency II and are continuing to do so. CEIOPS is also conducting a series of "Quantitative Impact Studies" (QIS) which are used to design and calibrate both the standard model and the rules for calculating the solvency liabilities. These QIS studies to date have been supported by a high degree of industry participation. In July 2007, the European Commission published a proposal for the forthcoming Solvency II directive. We are expecting that Solvency II will be implemented by 2012.

I have been impressed by the degree to which the supervisors and the European Commission have consulted, listened to, and taken up proposals from industry participants. This is reflected by some far reaching changes from their original proposals. An example, which comes to mind, is the adoption of the "Cost of Capital" approach for the valuation of liabilities, which has been put forward by the European insurance groups represented by the Chief Risk Officers' Forum.