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02

Getting to grips with a new regime

Open-access content Tuesday 2nd February 2016 — updated 5.50pm, Wednesday 29th April 2020

Karel Van Hulle, one of the original architects of Solvency II, considers the new regulatory landscape

2

As of 1 January 2016, some 4,000 insurance and reinsurance firms in the EU will have applied the new risk-based solvency capital regime, called Solvency II. It has taken about 15 years to develop, and while this might appear a long time, one should not forget that the introduction of a risk-based solvency capital regime constitutes the biggest reform in insurance regulation in the EU for 30 years.

Many stakeholders, including the actuarial profession, have been actively involved in the development of Solvency II. The regulatory process was bottom-up rather than top-down. The active engagement of so many people and experts will help to smooth the transition from Solvency I to Solvency II.

Solvency II establishes a link between risk and capital that will lead to a more professional way of conducting insurance business. From the conception of an insurance product, through the sales and claims handling process, insurers will have to be mindful about the capital consequences of the risks that they are taking.

A crucial element of the reform is the dialogue established between the supervisory authority and the supervised entity. This is enshrined in Solvency II through the review process, which automatically starts when an insurer breaches the solvency capital requirement (SCR). It is also present in the discussion between the supervisory authority and the supervised entity about the own risk and solvency assessment (ORSA), which must be carried out by the insurer at least once a year. This dialogue should not be a monologue.

Both parties will have to learn to discuss solvency issues based upon a relationship of trust.

Through the establishment of an actuarial function as a key governance function, the actuarial profession will gain importance under Solvency II. The person in charge of the actuarial function will have to produce a report and communicate their findings to the board and to the supervisory authority. Actuaries will therefore have to get used to translating complex issues into understandable language, and to identify the strategic consequences following from numbers and models.

Not everything will go well from day one. That cannot be expected.
Important regulatory reforms take time to bed down in daily practice. One should therefore be cautious not to amend the regime before sufficient experience has been gained. Solvency II was designed as a flexible regime that can be adapted when needed in order to bring the rules in line with changed circumstances.

There is, however, pressure already to change the regime by lowering the calibration for certain investments and amending the market-consistent valuation of assets and liabilities. Changes should only be carried out after careful study and a thorough impact assessment.
Solvency II comprises four levels of regulation: the Solvency II Framework Directive (level 1), delegated regulation from the European Commission (level 2), the regulatory and implementing technical standards developed by European Insurance and Occupational Pensions Authority (EIOPA) (level 3) and the (non-legally binding) guidelines developed by EIOPA (level 4). The total regulatory package now comprises several thousand pages. This is clearly too much and not in line with the principles-based approach that was one of the objectives of Solvency II.

Neither insurers, nor insurance supervisors will be able to monitor in detail all the rules that make up Solvency II. This is not a problem in itself. It is crucial that from day one, both insurers and insurance supervisors concentrate on the important issues and they apply the principle of substance over form.

It is equally important that national legislators as well as insurance supervisors avoid introducing further rules at national level (gold plating). This will require some discipline - not all problems can or should be resolved. Some experimentation is unavoidable and good. From applying the rules in practice, all parties concerned will learn where the strengths and the weaknesses in the new regime can be found.

Many countries in the world are looking at the experience the EU has gained with the development of Solvency II. Much can indeed be learned from the in-depth analyses that have been carried out and from the sometimes difficult negotiations that have taken place.

This does not mean that Solvency II is a perfect regime or that it is the best solvency regime in the world. It is, however, a regime that came about after much reflection and debate. It is therefore in the interest of any country in the world, which wants to move its solvency regime in the direction of a risk-based capital one, to learn from the experience gained with the development of Solvency II.


Karel Van Hulle is associate professor at KU Leuven and Honorary Fellow at the IFoA.
He will be discussing 'Harmonising solvency regimes across a region' at the IFoA Asia Conference on 3-4 March 2016. bit.ly/1P6AOke
This article appeared in our February 2016 issue of The Actuary.
Click here to view this issue
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