The adoption, by the European Union’s Economic & Financial Affairs Council, of the Solvency II framework directive is set to have a massive impact on the global insurance industry, not just those that are based in Europe.
The regulations which, when they are implemented in full in 2012, will change the way the insurance industry determine their capital requirements and, by extension, run their businesses as well.
James Tufts European Actuarial Services Partner at Ernst & Young, explains that the regulations will introduce a risk-based system for determining the capital requirements of insurance firms replacing the Solvency I regulations that have been in place since 2004, but which are based on rules that date back to the 1970’s. These existing rules do not take heed of the advances in risk management that have taken place over the past few years, are not in line with international best practice and are not suitable for supervising multinational diversified financial services groups.
“Insurers will have to build strong risk-management competencies to ensure they comply with the new regulations,” he explains. “It is also important that this risk management capability is not centralised in a single department within insurers but rather extended across all areas of management.”
Dries de Wet, South African Associate Director for Actuarial Services at Ernst & Young, comments that while the regulations are officially only binding on European insurers, there is a high likelihood that South Africa will introduce similar regulations. “Historically South African has followed the lead of the European regulators and as such we would expect a South African version of Solvency II to be introduced in time.”
“However, it is likely that South African insurers will move initially on their own accord to modify their systems to introduce some aspects of the Solvency II regulations on an internal basis. The reason behind this action is partly to preempt similar regulations on a local basis and partly to introduce better risk management processes into their own businesses,” he comments.
“Solvency II is based around three pillars, pillar one sets out the rules for measuring the amount of capital each insurer should hold, pillar two illustrates how risk management and governance should be handled and the third pillar governs disclosure and transparency requirements for insurers,” de Wet explains.
Tufts adds that while the move to introduce new regulations to govern insurance companies has been in the works for a number of years, it goes a long way to answering a number of criticisms that have been levelled against the industry in the wake of the recent financial crisis.
“One would like to believe that had the world’s insurance companies already been using the Solvency II regulations, then there would have been significantly more advance warning about the difficulties that some of the international insurance companies were experiencing at the time and the scope of intervention might not have needed to be as dramatic as was sometimes the case,” comments Tufts.
He explains that the new regulations set a number of solvency control levels which when breached would alert regulators that a specific level of intervention was needed ranging from working with the insurer to restore solvency levels to implementing the “ultimate supervisory action” where the insurer's liabilities would be transferred to another insurer and the license of the insurer will be withdrawn or the insurer will be closed to new business and its in-force business will be liquidated
With a move to an open and transparent approach to regulating the insurance industry, companies will be better prepared to survive difficult periods and with the introduction of defined solvency control levels, regulators will be better able to assist insurers that are in difficulty.
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