14 March 2016

Financial Times: Solvency II: Insurers split over EU’s shared rules

Even after more than a decade and a half of planning, discussion and fine tuning, the EU’s Solvency II insurance rules are displaying their potential to divide opinion in the industry.

The regime came into force on January 1 and is the biggest change in European insurance regulation since the 1970s. Out goes a patchwork of local systems, in comes a common set of rules across the EU.

Jeff Davies, partner at EY, sees two big differences from previous regimes. “The first is that it is a market value balance sheet, whereas for most of Europe it was a book value balance sheet before. Moving to market values will make balance sheets more volatile,” he says.

The other is a move to what is known as a “risk-based approach” to capital and regulation. Insurers have to ensure that they have enough capital on their balance sheets to withstand a level of stress that is deemed likely to happen only once every 200 years. The risks to assets and liabilities are examined in a far more detailed way than before.

At a very high level, Solvency II shares some features with the equivalent in the banking world, Basel III. It is a three-way approach to supervision: the first is the calculation of capital levels; the second is internal control and supervision by regulators; and the third is supervision by the market, with added reporting requirements so that outsiders can come to their own conclusions.

As with Basel III, there are transitional rules to help companies adapt to the regime. So January 1 was for many insurers part of an evolution from what they used before, rather than a revolution. As with the banks, insurers can use either internally developed models or standardised models produced by regulators to work out their capital requirements.

That is where the similarities end. The long process required to create the new system shows how complex it was to create a common set of rules to cover national insurance markets that had evolved in very different ways.

For now, the main focus for analysts and investors is the Solvency Capital Ratio or SCR. This is a measurement of the amount of capital that insurers have available as a proportion of the minimum required. The higher the ratio, the more spare funds the insurer has.

Regulators and insurers have been at pains to stress that the ratios are not comparable with those that were used before or with those reported by other insurers because of the different ways that the rules have been interpreted.

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