Solvency II is a new, stronger EU-wide requirement on capital adequacy and risk management for insurers with the aim of increasing protection for policyholders. The strengthened regime should reduce the possibility of consumer loss or market disruption in insurance.
Solvency I was a minimum harmonization directive introduced in the early 1970s. It allowed for differences to emerge in the way that insurance regulation was applied across Europe leading to different regimes. It was also primarily focused on the prudential standards for insurers and did not include requirements for risk management and governance within firms.Solvency II aims to achieve consistency across Europe on the key ideas of:
- Market consistent balance sheets;
- Risk-based capital;
- Own risk and solvency assessment (ORSA);
- Senior management accountability; and
- Supervisory assessment.
The Solvency II Directive states that the new regime will go live on 1 November 2012 when it will replace the Solvency I requirements and the current regulatory regime for insurance supervision for firms in the UK. The European Commission’s (EC) proposals for the Omnibus II Directive include an amendment to the implementation date by two months to 1 January 2013.
The new regime will apply to all insurance firms with gross premium income exceeding €5m or gross technical provisions in excess of €25m. Some insurance firms will be out of scope depending on the amount of premiums they write, the value of technical provision or the type of business written.
Solvency II principles and rules apply to Lloyd’s of London syndicates in full. Due to its specific nature, some of the Solvency II requirements are being considered for their application to Lloyd’s.
Solvency II is being created with a four-level process or the ‘Lamfalussy processes
· European Commission adopts formal proposal for Directive/Regulation. Council and European Parliament adopt legislative act.
· European Commission requests EIOPA advice on delegated acts and implementing acts (Directives or Regulations). EIOPA drafts technical standards and European Commission adopts (Regulations or Decisions - sometimes referred to as 'binding level 3').
· EIOPA adopts ‘comply or explain’ guidelines and recommendations, carries out peer review, mediates and settles agreements, takes action in emergency situations, facilitates delegation of tasks and responsibilities, monitors and assesses market developments, undertakes economic analyses and fosters investor protection.
· Strengthened enforcement of European Union law (EIOPA and European Commission).
Sovency II Requirements:
Solvency II is split into three major requirements:
1. It covers all the financial requirements. It ensures the firms are adequately capitalized with risk-based capital. All valuations in this pillar are to be done in a prudent and market consistent manner. This pillar also includes the use of internal models which, subject to stringent standards and prior supervisory approval, enable a firm to calculate its regulatory capital requirements using its own internal model.
2. It imposes higher standards of risk management and governance within a firm’s organization and gives supervisors greater powers to challenge their firms on risk management issues. The ORSA requires a firm to undertake its own forward-looking self-assessment of its risks, corresponding capital requirements and adequacy of capital resources.
3. This aims for greater levels of transparency for supervisors and the public. There is a private annual report to supervisors, and a public solvency and financial condition report that increases the level of disclosure required by firms. Our current returns will be completely replaced by reports containing core information that firms will have to make to us on a quarterly and annual basis. This will ensure that over all, we have better and more up-to-date information on a firm’s financial position.