Solvency II details must remain true to regime’s goals

The European insurance industry has, from the outset, strongly supported Solvency II. Insurers back its ambition to ensure high levels of policyholder protection and encourage good risk management through sophisticated measurement of risks and risk mitigation. Unfortunately, it has taken rather longer and proved rather harder than originally hoped to achieve those goals.

The main cause of the delays has been the treatment of long-term guarantees and long-term savings. A full test of the framework was run in autumn 2010 in the midst of the financial crisis. This showed that a number of design and calibration issues would need fixing if Solvency II were to work as intended. Most important among these was that the measurement system on which Solvency II was based did not take into account the long-term nature of the business, meaning that the short-term volatility caused by the financial crisis was having a disproportionate impact on solvency.

Investing long-term gives insurers numerous advantages from which their policyholders benefit through higher returns for their savings and pensions. Most importantly, from a risk measurement point of view, insurers can hold assets to maturity and have great flexibility over which assets they sell at a given time.

What the test run in 2010 showed was that the measures themselves – rather than the actual risk exposure – would have had a dramatic impact on the provision and price of long-term guarantees and on the ability of the industry to invest long-term. They would have also turned an industry that helped create stability during many financial crises into one that would be pro-cyclical. Given the industry’s crucial role in providing policyholder protection, financial market stability and growth, and its €8.4trn of assets to invest in the real economy, this became a political as well as a technical issue that had to be solved.

After more than a decade of development, in November last year policymakers agreed on the final version of Solvency II, making a range of political and technical changes to the original Solvency II Directive of 2009. This was done through the Omnibus II Directive, which the European Parliament officially approved on 11 March and the Council is expected to adopt in April. The agreement, while not ideal, includes a number of measures that better capture the long-term nature of the business, and it was welcomed by the insurance industry as a workable compromise.

Still not finalised

Even now, however, Solvency II is not finalised. The details –known as the delegated acts – still need to be completed and approved by the European Parliament and Council. These implementing measures contain very important calibrations and technical details on how the Directive will be implemented across Europe.

It is vital that the delegated acts currently being drafted by the Commission enable the new regime to work as planned. Excessive levels of capital or ones that do not correctly reflect risk exposures would increase the cost and decrease the availability of insurance products for buyers. The drafts we have seen need some major improvements if the framework is to work as intended.

Implemented correctly, Solvency II will promote consumer confidence, and it will safeguard the European industry’s ability not only to offer a wide range of innovative products at appropriate prices and to compete internationally, but also to support European growth through investment.

Solvency II’s mix of solvency capital requirements, complemented by the equally important risk management, governance and reporting requirements, should enable some insurers to better understand their underlying risk exposure and allow them to adjust the pricing of their products or develop new, innovative ones.

Finally, Solvency II contains a further advantage for insurance buyers: a deepening of the EU single market. Harmonisation of the supervisory framework across EU jurisdictions, along with a radically new approach to group supervision, should stimulate competition.

Olav Jones is Deputy Director General and Director of Economics and Finance of Insurance Europe, the association of European insurance businesses.