What is Solvency II ?

Solvency II is both a concept and a process. The concept is very simple: that insurers and reinsurers should understand the risks inherent in their businesses and allocate enough capital to cover those risks.

The process of putting it into practice, however, is much more complex. It involves regulators from all EU countries plus Switzerland, Norway, Lichtenstein and Iceland. Although the basic principles are agreed, there are still differences over implementation, which will not take place until 2010 at the earliest.

What difference will Solvency II make?
Although the details are still to be agreed, there’s no doubt that Solvency II represents a radical change in the way that the industry is regulated.

The approach recommended by the commission is very similar to that of the FSA in the UK, which practically requires insurers and reinsurers to produce financial models. Some regulators, however, argue that it should be simplified to make it easier for smaller or less sophisticated operations.

The proposals are based on the so-called three pillars. These cover

1) capital requirements
2) the supervisory activities of regulators with the aim of identifying firms with a higher risk profile and
3) disclosure of additional information.

Whatever the outcome, however, the requirement to demonstrate that you have accurately measured and allowed for the risk in your business will be at the heart of Solvency II.

When is the best time to begin planning?
You should be doing so now. The principles behind Solvency II are good practice regardless of any regulatory considerations. Applying them can bring a range of benefits, making your business more stable and helping to make better use of capital.

The ratings agencies are increasingly applying the principles of Enterprise Risk Management, which are almost identical to those behind Solvency II. Any insurer or reinsurer with an interest in its security rating needs to take note.

Furthermore, a growing number of regulators outside the EU, such as Australia, South Africa and some Asian countries, have already moved or are moving in the same direction. This may affect any company with international interests outside Europe.

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