The FSA held a Solvency II Conference on 18 April 2011 in London, in which it outlined key outstanding issues and implementation strategies in the run up to the 2013 deadline. The message was clear: Solvency II is coming and we must be ready for it.
Solvency II: a one-in-fifty-year regulatory eventYou may think that implementing Solvency II in 2013 marks a decade of progress in European solvency regulation. You may think that. But you would be wrong. Even though its predecessor, Solvency I, came into effect in 2002, conceptually Solvency II marks a giant leap forward. [caption id="attachment_758" align="alignright" width="254"] Hector Sants ©FSA “Our ambition has not been to increase or decrease the amount of capital supporting the UK insurance industry, but rather to ensure that capital is more appropriately aligned with risks.”[/caption] Speaking at the FSA Solvency II Conference, Paul Sharma, Director – Prudential Policy at the FSA, explains why the gap is so large. “[EU] solvency regulation was first introduced in the 1970s,” but, Mr Sharma said, “it was negotiated in the 1960s and was based on 1950s data. In European terms this profound rewriting of the regulatory approach for Europe is a once in a fifty year event.” The need for reform was brought sharply into focus by the recent financial crisis. Hector Sants, Chief Executive Officer of the FSA put it succinctly when he told the audience: “One of the most fundamental lessons from the crisis was that firm management did not know the answer to the simple question: under what circumstances will my firm fail?”
Aligning capital with riskSolvency II sets out to create stronger EU-wide requirements on capital adequacy and risk management for insurers in order to increase protection for consumers and markets. Speaking of the UK market, but this could well apply to the rest of the EU, Mr Sants said: “Our ambition has not been to increase or decrease the amount of capital supporting the UK insurance industry, but rather to ensure that capital is more appropriately aligned with risks.” As they prepare to meet the Solvency II deadline, regulators and insurers are like a group of surfers bobbing cautiously in the water as a huge wave swells up ahead. The surfers must time their progress to make contact with the moving mass of water. Get it right and you’re flying. Get it wrong, and you’re all over the place, with a mouthful of salty water. [caption id="attachment_768" align="alignleft" width="299"] FSA Solvency II Conference 18 April 2011 ©FSA[/caption] In the offices of insurers and regulators, managers are bobbing their organisations cautiously towards the swelling and shifting mass that is a set of changing regulatory requirements. With the final draft of the regulation only due in the latter part of 2012, a lack of clarity from the EU on key issues and a chronic shortage of qualified people, they too must negotiate their approach carefully. For them the question is: are we investing the right amounts in the right areas?
The FSA’s implementation planFaced with these challenges, both to itself and the industry, the FSA announced at the conference that it will focus on a small number of key firms in the run up to the implementation deadline. During the pre-application phase of the Internal Model Approval Process (IMAP) the FSA will pay closer attention to firms that represent a significant market share. These firms already notified the regulator of their intention to use an internal model to calculate the Standard Capital Requirement (for more details see Solvency II – IMAP update Pre-application process). According to Julian Adams, the FSA’s Solvency II Programme Sponsor and Director – Insurance, these will broadly include: the top ten UK life and non-life firms; firms operating in the Lloyd’s market; and subsidiaries of major European groups. Other firms already registered in the pre-application process will receive a lower level of interaction from the FSA’s actuaries and risk specialist. “By and large, the firms where we are applying our resources are the largest and most complex, and therefore those for whom the challenge of building and implementing a model will be the greatest,” explained Mr Adams.
Tools for developing the internal modelFor those firms that will receive a reduced level of attention, the FSA will soon publish a set of tools to help bridge the gap and “ensure their model development continues in the right direction”. These will include:
- “Stress testing for general insurance firms;
- reference portfolios to test model treatment of certain types of asset or business;
- industry standards on catastrophe models; and
- specified models for certain esoteric types of firm.”