Select Committee on European Union Sixth Report



1.  The Solvency II Directive[1] 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[2] 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[3]

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[4]:

"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 internal governance.

"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.

Our inquiry

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[5]. 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

2   The value of assets that an insurance company is required to hold at all times. Back

3   Source: HM Treasury. The process is named after former central banker Alexandre Lamfalussy, chair of the Committee that oversaw its development. Back

4   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

5   HM Treasury estimate political agreement will occur this year (p 30). Back

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