SimˈpōzēəmPaul Fulcher, European Head of ALM Solutions at Nomura Regulation must adapt to market developments. The long delays in implementing Solvency II resulted in an inevitable need to update the rules. But Paul Fulcher, European Head of ALM Solutions at Nomura, argues that the original commitment to value-at-risk and counter-cyclicality are contradictory and have produced the complex mess we now know as the Long-term Guarantees package. Traditionally, insurance regulation has focused on the long-term ability of insurers to meet claims as they fall due. The challenge for regulators has always been how to monitor this ability at intermediate points to ensure timely intervention. Under the current (“Solvency I”) regimes across Europe this is typically a retrospective assessment, without explicit reference to market data and a reliance on techniques such as book values, asset-based discounting, implicit margins and actuarial judgement. Solvency II, in its purest form, changes this by introducing a market-consistent valuation of assets and liabilities and a risk-sensitive capital requirement calibrated to a one year 99.5% VAR. Existing techniques are replaced by market prices, exogenous “risk-free” rates, explicit capital, and objective data. Solvency II is overhauling many established processes and in assessing its impact it is important to bear in mind that regulation is ultimately about political objectives rather than being an exact science. The key political rationale behind the original directive was to introduce a harmonised, modern, risk-based and prospective assessment of solvency. But insurers cannot be risk-free unless capital is infinite. And the level of acceptable risk is also political. In particular, there is nothing sacred about a 99.5% confidence level assessed over a one year horizon. Different confidence intervals and different assessment periods – including run-off – could have equally met this political rationale.