CHAPTER 1: THE BACKGROUND TO SOLVENCY
1. The Solvency II Directive
is a wide-ranging revision of the regulation of insurance and
reinsurance companies operating in the EU. Regulation of insurance
and reinsurance activities in the European Union is at present
the subject of 13 separate Directives, some of which date back
to the 1970s. They do not reflect current market practice or risk
management capabilities, and have been found wanting in recent
downturns (QQ 2, 39). In addition to the need to update the
regulation of this industry, the Commission has proposed measures
which it believes will enhance policyholder protection, strengthen
the single market for insurance and reinsurance, and improve the
international competitiveness of EU insurers and reinsurers.
2. Solvency II is one of the outstanding items
from the Commission's Financial Services Action Plan (1999-2005).
Solvency I raised the Minimum Guarantee Fund
in 2002 but was designed to be a temporary measure to improve
policyholder protection whilst a more fundamental reform project
was undertaken. The Commission commenced the Solvency II project
in 2004, and has consulted regulators (through the Committee of
European Insurance and Occupational Pensions Supervisors (CEIOPS))
and market practitioners (through groups such as the Comité
Européen des Assurances (CEA)) in the period prior to publishing
the draft Directive.
3. The Directive is being introduced under the
Lamfalussy process. The Lamfalussy arrangements were established
for securities markets in 2001 and subsequently extended to banking
and insurance in 2004. They are designed to increase the efficiency
of the EU legislative process and enhance cooperation and convergence
of supervisory practice between the EU's national supervisory
authorities. They are set out in detail in Box 1.
The Lamfalussy arrangements
4. The Commission's proposal, published on 19
July 2007, is the Level I framework Directive and as such sets
out high-level principles and the requirements that constitute
the core of the new prudential framework. The Directive will give
the Commission the power to develop Level II implementing measures
which will specify the technical detail of the framework.
5. In its Explanatory Memorandum (pp 26-30),
the Government summarises the content of the proposed Directive.
The legislation is based on a three pillar approach, similar to
that used in the Basel II banking accord:
"Pillar 1 covers principles for the valuation
of insurers' assets and liabilities, in particular the liabilities
to their policyholders. It also sets capital requirements and
defines what kinds of capital are eligible to meet those requirements.
Pillar 1 provides for a harmonised standard formula for insurers
and reinsurers to use in calculating their capital requirements,
and, subject to supervisory approval, allows the use of insurers'
own internal models to calculate the main capital requirement
which Solvency II will impose.
"Pillar 2 defines qualitative requirements
that insurers and reinsurers will be required to meet as part
of the process of supervisory review of their business by regulators.
All firms regulated by the directive will be required to undertake
an assessment of the risk to their business, the adequacy of their
capital resources and to determine the appropriateness of their
"Pillar 3 sets out requirements on disclosure
of information that firms will have to release both to regulators
and publicly. Insurers and reinsurers will be required to produce
annually a public report which will include information on capital
and risk management." (p 26, emphasis added)
6. The Commission and CEIOPS have also undertaken
a series of three Quantitative Impact Studies (QISs) and a fourth
is planned starting in the spring of 2008. The QISs allow the
impacts of different models and systems of risk mitigation to
be measured and the precise impact of the proposal on companies
participating in the Study to be calculated. The data are used
to model the wider impact across the industry. Due to the technical
nature of the proposals, the potential impact of Solvency II will
not be known until the final Directive is agreed, but the QIS
process allows the Commission, regulators and the industry to
examine the likely outcome of different approaches.
7. This report, carried out under our remit to
scrutinise proposals for European legislation before the United
Kingdom's agreement at the Council of Ministers, considers the
progress to date and notes concerns that we believe need to be
addressed before the Directive is agreed.
The membership of the Sub-Committee that undertook this inquiry
is set out in Appendix 1. We are grateful to those who submitted
written and oral evidence, who are listed in Appendix 2. We
make this report for information.
1 11978/07 COM(2007) 361 Back
The value of assets that an insurance company is required to hold
at all times. Back
Source: HM Treasury. The process is named after former central
banker Alexandre Lamfalussy, chair of the Committee that oversaw
its development. Back
Basel II is the second of the Basel Accords-recommendations on
banking regulations issued by the Basel Committee on Banking Supervision.
The accord, which is in the process of being adopted by banking
supervisors in most countries, proposes an international standard
capital requirement for banks. Back
HM Treasury estimate political agreement will occur this year
(p 30). Back