Five action points for supervisors

COMMENT

Felix Hufeld, Chief Executive Director Insurance Supervision, BaFinPreparing for Solvency II is as great a challenge for supervisors as it is for firms. Felix HufeldChief Executive Director Insurance Supervision at the German regulator BaFin, proposes five action points supervisors should embrace to manage the change and successfully implement Solvency II.

After years of discussions, deliberations and negotiations a break through decision was reached by the EU trilogue parties in November last year. Now we know that Solvency II is going to be reality as of January 1st 2016, although this is not entirely true. Already from January 1st 2014 the preparatory phase for Solvency II has started and is governed by a comprehensive set of Guidelines issued by EIOPA. These Guidelines are supported by an even more comprehensive explanatory text offering guidance on a broad range of technical issues.

So as not to get lost in a vast amount of technical details, I believe it is essential to remember what Solvency II at its very core is all about. In my view it is based on the following four principles, each representing a major paradigm shift in the regulation and behavior of insurance firms.

Solvency II is a shift from a rules based regulation to a principles based regulatory regime entailing a much higher number of vague legal terms to be applied in practice. The Prudent Person Principle is a perfect example.

We are moving from a rather reactive to a much more proactive perspective embedded in a system of risk management requirements and governance structures. The ORSA process is the prime example, as it forces companies to continually employ a forward looking approach as a basis for its dialog with the supervisor.

Solvency II also moves us away from a book-value toward a market-value based system that will enforce a more realistic calculation of solvency capital needed and may influence pricing as well, particularly for long term business. Despite many technical challenges associated with the Long-Term Guarantee measures and introducing a higher level of volatility, this paradigm shift is essential for creating a sustainable and risk-based regulatory framework.

Finally, Solvency II introduces a significantly higher level of data transparency both in scope and frequency. This is clearly a lesson taught by the recent financial crisis and a prerequisite for the above mentioned improvements in forward looking risk management. Needless to say this implies a major burden for the industry regarding IT, people and process-design.

To navigate through a myriad of technical requirements it will be important not to lose sight of the above mentioned principles.

They do, however, represent a massive challenge not just for the industry but for supervisors as well. As for each insurance company, every supervisory authority needs to get itself organized and prepared for a whole new range of tasks. Each of these four paradigm shifts requires an equivalent set of skills to be developed by supervisors – skills that have been less relevant in the past.

It seems to me there are at least five action points to be considered by a supervisory authority to successfully prepare its respective industry as well as itself for Solvency II.

Get yourself organized:
In many cases proven tools of project management will have to be applied. But at the same time the authority should have a clear understanding how to merge such temporary structures into its regular and permanent organizational design eventually.

Vis-à-vis the industry the authority should be as transparent as possible about how it wants to organise the preparatory phase including elements of dialogue, supervisory guidance, implementation surveys, etc.

Training:
Don’t underestimate the amount of time, resources and leadership effort needed to equip supervisors with the skills and technical knowledge needed to perform their new roles required under Solvency II.

Knowledge Management:
To supplement and secure the benefit of training over time a more dynamic concept of Knowledge Management needs to be established. This may include elements such as FAQ’s, a continuously updated database of guidelines and directives, and providing the opportunity for lateral discussions and learning among colleagues. This will add an important pull element to the push provided by training.

Rewrite supervisory handbooks:
Lacking many familiar and proven rules under a more principle based regime, supervisors need a new conceptual framework of how to engage with insurance companies on a practical day-to-day basis; and how to do so in a consistent way across departments as well as over time.

Change Management:
Some people call Solvency II a ‘cultural revolution’. Indeed none of the previously mentioned, more factually based measures would work without people changing long-established habits and customs.

Change inevitably meets resistance if it is not supported by a deliberate and continuous process of Change Management. By the same token however, Change Management must be established outside of the usual management hierarchy and must not be based on command and control or persuasion. Rather it should be driven by listening and addressing personal perceptions, concerns and emotions.

The goal should be to ultimately align people’s intrinsic motivation with the technical requirements of a complex change process. This is a delicate challenge but absolutely worth the effort. It goes without saying that this is equally important both for companies as well as supervisory authorities.

Specific approaches will vary from country to country depending on size and legal, political and cultural environments. But it is fair to say that the effort required to introduce Solvency II probably concerns each and every insurance company as much as supervisory authorities.

We have a clear date of implementation; we have a clear legislative basis (with more technical specifications to be developed on Level 2 and Level 3 texts); and we have a clear commitment of the supervisory community as well as industry in Europe to move on. Now we are in the driver’s seat and it is (almost) entirely up to us to stay in the fast lane and deliver safely what definitely represents the most significant regulatory reform in decades: Solvency II.

The author is Chief Executive Director Insurance Supervision at the German Federal Financial Supervisory Authority (BaFin). The views expressed are the author’s own.

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  2 comments for “Five action points for supervisors

  1. Paul
    February 7, 2014 at 12:45

    “Solvency II is a shift from a rules based regulation to a principles based regulatory regime”

    Interesting to see that is the perspective from outside of the UK.

    Because from a UK perspective the shift is entirely in the opposite direction – comparing the very detailed rules around the matching adjustment to the current principles based approach in Individual Capital Assessment being one obvious example.

    I would think the biggest issue the UK regulator would face would be their inability to use regulatory discretion in interpreting much of Solvency II – for example Julian Adams speech in December where he said the PRA “will not be reproducing or providing significant interpretation or elaboration of European legislative or regulatory material. Indeed, we are not entitled to do so”.

    • Martin
      February 20, 2014 at 18:25

      Paul,

      It is reasonable for Herr Hufeld of the German regulator to write from a German perspective. Solvency II is intended to be harmonising legislation, so different countries and their industries and regulators have different tasks ahead. In the UK, I believe that we have to accustom ourselves to both detailed rules about capital requirements calculations and the principles that underpin them.

      I agree that a more helpful approach from the PRA would be welcome, especially during what is a “preparatory phase”.

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