Lloyd’s Comments on Approaching Implementation of EU’s Solvency II

Lloyd’s of London notes that “after almost a decade of development regulators are now putting the finishing touches to Solvency II, new rules governing European insurers’ capital adequacy.

The regime is set to modernize the way European insurers are supervised, further developing the industry’s risk management and fostering regulatory harmonization across Europe and with key insurance markets around the world.” The regulatory guidelines are scheduled to go into effect on January 1, 2013. Member countries of the EU will be required to pass the necessary legislation to implement them.

The new regulations will replace Solvency I, which more or less concentrated on capital levels and reserves as indicators of a given insurer’s economic condition. Solvency II recognizes the “need for a more harmonized and modern approach in the 1990’s.”

Solvency II “incentivizes insurers to invest in risk management and sets capital levels to reflect individual insurer’s business,” Lloyd’s noted. “At its heart is a focus on risk. Each insurer is required to identify and manage all the risks it faces – whether they are related to underwriting, investment or markets – and understand the implications for the capital it holds. The new framework also enables insurers to use sophisticated models to calculate capital requirements that better reflect the risks they face.”

“Under Solvency II insurers are required to demonstrate the use of risk analysis and risk monitoring, supported by relevant data in the daily running of the business, as well as in business and strategic planning,” explained Patricia Hakong, Head of Finance and Risk Management at Lloyd’s Market Association.

Lloyd’s also explained that “supervisory practices around the world, and even within Europe, vary considerably. Some countries, like the UK, have embraced risk-based regulation in recent years, but many maintain unsophisticated regimes with little or no tolerance for insurer insolvency. While this means they have experienced very few failures in the past, market efficiency may have suffered through higher prices and less innovation.

In addition the new regulations will have an impact outside of Europe. “Solvency II is being watched carefully by regulators overseas, keen to establish a level playing field with Europe or just learn from best practices,” said Lloyd’s. “It is considered by some as a potential model for future insurance regulation internationally and includes mechanisms for greater cooperation with non-EEA regulators.

“In particular, leading insurance markets in Bermuda and Switzerland have revised their own regulatory regimes to bring them in line with Solvency II. These countries are working with the EU to achieve “equivalence” of policyholder protection, which should increase security further through coordinated supervision of insurance groups and reduce the cost of compliance for those operating across borders.

“In the long term regulatory equivalence could see greater alignment with other supervisory regimes, notably the US and Japan, which are at differing stages of reforming their own risk-based framework.

Source: Lloyd’s of London