The critical importance of Solvency II to SA insurers

"Solvency II, the new regulatory insurance requirements for Europe, is now relevant to SA insurers and will change capital requirements here through its more refined approach" says David Kirk, Associate Director in the Actuarial and Insurance Management Solutions practice of PricewaterhouseCoopers SA. "However, the goals and paths of European and SA insurers differ and local insurers will have to weigh up the costs and advantages in deciding how best to benefit from Solvency II."

Kirk says Solvency II, which has adopted the Three Pillars of the Basel Accord on banking, has been designed to address the tangled mess of simplistic, risk-insensitive and inconsistent requirements seen in Europe which actually encourage risk-taking and discourage prudence in reserving. "Its primary aims in Europe are to improve customer protection, deepen market integration, increase international competitiveness of European insurers and create a clearer focus on prudential supervision for groups."

While recognising there are certain areas where Solvency II does not have the same benefits for SA companies as it does for Europe, and may not always translate directly to SA, Kirk says there are several areas where implementing Solvency II-like models is critically important for local insurers.

In an article in the recently published PwC Southern African Financial Services Journal, Kirk says "Firstly, for SA insurers interested in pursuing European opportunities, either at an operational or shareholder level, compliance with Solvency II principles will improve their credibility in dealing with European stakeholders.

"Also, our Financial Services Board is a member of the International Association of Insurance Supervisors and has supported the ideas behind Solvency II, in principle. 'Financial Condition Reporting', closely linked with Solvency II, for general insurers, shows the direction of the FSB's thinking."

Kirk says its is likely that rating agencies and the FSB will follow developments in Solvency II when considering what weight to give various forms of capital in supporting the risks an insurer faces.

"Many local insurers are developing internal economic capital models. For large and small insurers alike, Solvency II provides a carefully thought-out framework for developing such a model and provides a template to use and adapt as necessary without reinventing the wheel. For those insurers that have made significant progress with their internal models, the Solvency II approach and its proposed standard calibration provides a "sense check". This is especially relevant given the difficulty of calibrating many areas of these models."

Kirk says that some small and medium SA insurers have no immediate plans to create fully fledged internal models due to the high development costs. "But Solvency II can suggest a path to refine PGN104's Capital Adequacy Requirement in key areas that provide maximum benefit at quite a reasonable cost." (PGN104 is The Actuarial Society's Professional Guidance Note 104 "Valuation of Long Term Insurers" which provides for a risk-based capital requirement termed the "Capital Adequacy Requirement")

Another consideration is that internal audit and integrated risk management functions will form an important part of the Solvency II regulatory environment. With few exceptions, internal audit in SA does not form a key part of the integrated risk management of market and insurance risk. Risk management functions tend to focus on operational and credit risk in isolation of corporate actuarial departments' efforts on insurance and market risk. The linking up of corporate actuarial, risk management and internal audit is a pre-requisite for a shift to a Solvency II world.

Kirk says some differences in a Solvency II approach followed by SA insurers should include a more accurate solvency capital requirement when comparing portfolios with different degrees of diversification across asset classes. "Also, market risk capital requirements for SA long-term insurers under a Solvency II approach could be significantly different. It may also encourage careful consideration of the diversifying benefits of asset allocation. And many insurers will find that they need to update their systems to allow for the valuation of assets and liabilities using yield curves - rather than single spot rates - to accommodate the more advanced shock scenarios underlying Solvency II."

Kirk observes it is clear that a significant proportion of SA insurers are embarking on these steps already." Those that get left behind at this stage will find catching up challenging. Solvency II's three pillars have become clearly defined goal posts with compelling advantages for South African insurers."