What happens in Europe over the next few years, will determine the future path of insurance regulation and, quite possibly, the path of all financial services regulation. Solvency II entered into force on 1 January 2016. As the Directive is rolled out across Europe its application and its success – or failure – will be watched closely by many.
Firms will watch closely – still trying to make sense of the rules, understand how they are to be applied in practice and interpret the intentions of the regulator. They will also watch each other, trying to figure out best practice and, above all, find that all-important SCR ratio comfort zone (what percentage of the SCR above 100% is good enough in the eyes of the world?).
Regulators will watch developments on two levels. At the micro level they will want to test the resilience of each firm and at the macro level, that of the national market.
Member States will also watch the impact on national markets as well as their own interpretation of the rules and any claims of “gold plating” or “rust plating”.
Continents too will watch Solvency II. First and foremost, Europe, of course: monitoring the consistent application of the Directive by individual Member States, tracking convergence and overall impact on the European market. It will be up to the Commission, through EIOPA, to make sure the rules are applied consistently.
Expect this to be a hotbed of activity in years to come. Across the Atlantic, the Americas will watch closely. The US is monitoring the remaining equivalence decisions and the impact they will have on its markets. Despite protestations it cannot avoid the charms of Solvency II in the ORSA and group capital rules. To a lesser extent Latin America will watch too, as its major economies are in the process of adopting regimes that are based on Solvency II to varying degrees.
Across the Pacific, Asia will watch. Japan has been granted Solvency II equivalence for reinsurance and is moving towards modernising its insurance regulation along the lines of Solvency II. And China will be keen to see what happens as its own version of a Solvency II based regime, C-Ross, is being rolled out at breakneck speed. Above them all, at a supranational level, the IAIS will be watch, as it battles to produce a cohesive global capital standard and consolidate the status of its Insurance Core Principles – the latter sharing much with Solvency II.
A driving force
Solvency II has been the driving force behind the modernisation of insurance regulation across the globe. Among the many changes it introduces to the regulation and running of insurers and reinsures, two stand out.
First, Solvency II tries to form a more realistic valuation of insurers’ assets and liabilities based on market values. Second, it places governance at the core of management and supervision of the insurance industry. The high capital standards set by Solvency II are driving the discussion on international capital standards at the IAIS where there is a fierce political and technical debate on the appropriate methodology to be used.
If Solvency II proves unworkable at the individual entity level (it remains to be seen how effective the Matching Adjustment and Volatility Adjustment will be) it will give strength to those who shun the market consistent approach and could drag the whole concept down with it. The bigger issue at stake is that of governance. Pillar II and the ORSA may not get as much publicity as the capital requirements, but they are already having a profound impact on the day-to-day running of the insurers’ business – reaching far beyond the narrow domains of the accounting and finance departments.
If governance proves effective in protecting insurance firms and markets it may gain prominence in the debates on the role of governance versus capital in financial services regulation, and the on-going saga of rules versus principles based regulation. At a more fundamental level the application of Solvency II in a consistent manner across Europe’s diverse insurance markets will be addressing what is possibly the most pressing question in international insurance regulation today: is it possible to create a global standard for insurance? Banking has always been an international industry and it essentially deals with one type of liability: money. Insurance has grown locally out of the specific and idiosyncratic nature and needs of local markets.
A global standard would be good, but the lesson from Solvency II might be that insurance is not as uniform as banking. It may be that finding the equivalent of a USB port (Universal Serial Bus) for insurance will remain elusive. What happens in Europe over the next few years will by no means just stay in Europe. For now we all watch and wait.
Gideon Benari is the Editor of Solvency II Wire.