Memorandum by the Association of British
The ABI (Association of British Insurers) represents
the collective interests of the UK's insurance industry. The ABI
speaks out on issues of common interest; helps to inform and participate
in debates on public policy issues; and also acts as an advocate
for high standards of customer service in the insurance industry.
Many of our leading players are internationally active with operations
around the globe. Some are not headquartered in the UK.
The ABI has around 400 companies in membership. Between
them, they provide 94% of domestic insurance services sold in
the UK. Our member companies account for almost 20% of investments
in the London stock market.
On 10 July 2007 the European Commission published
a proposal for a Solvency II Framework Directive. The draft Directive
sets out a comprehensive new framework at EU level for the prudential
regulation of insurance companies. This includes determination
of appropriate capital standards and supervision of insurers'
risk management and governance. The proposal has been published
following a long period of consultation with national authorities,
industry bodies, consumer groups, and especially at the Committee
of European Insurance and Occupational Pensions Supervisors (CEIOPS),
the EU committee where national insurance regulators meet. The
Commission's objective is to introduce a more sophisticated, risk-based
approach to prudential regulation of insurance applied on a consistent
basis across the EU. Regulatory capital requirements will be set
using modern techniques for a market-based valuation of the assets
and liabilities on insurance companies' balance sheets.
The current EU level regime for the prudential
supervision of insurers ("Solvency I") dates back to
the 1970s. Capital requirements are calculated using a percentage
of premiums paid by policyholders, with no attempt made at a realistic
assessment of risk. Many regulatory bodies, including FSA in the
UK, but also the Dutch and Swiss insurance regulators, have moved
to a more accurate assessment of risk, based on sophisticated
internal models and stress tests.
In the UK the Individual Capital Adequacy Standards
(ICAS) were introduced in 2003. These reforms have been internationally
acknowledged as a success, aligning insurers regulatory capital
assessment with their own internal risk assessment. An overhaul
of the EU framework is therefore very timely and highly desirable.
The Commission's proposal similarly seeks to
apply a more sophisticated approach to risk and capital assessment
across the EU, recognising the important role insurers' own internal
capital models can play in this process. Accordingly, Solvency
II will require insurers to develop more sophisticated tools to
understand and manage their risks, which will ensure a more accurate
allocation of capital to mitigate these risks.
encourage a more competitive single
EU market for the benefit of consumers;
achieve a more efficiently priced
market for insurance products and help EU insurers expand their
businesses around the world; and
increase efficiency in the use of
capital, improving financial returns.
Annex A sets out the anticipated timetable for
agreement of the Solvency II project, which follows the Lamfalussy
process. We expect agreement on the Level I Framework Directive
in the Council of Ministers and European Parliament by end 2008.
The Commission will then propose Level II implementing legislation,
to be agreed by early 2011. Transposition into national legislation
will follow. We expect Solvency II to be in force in the UK by
The Solvency II proposal follows the model first
introduced by the Basel Committee on Banking Supervision, grouping
requirements into three pillars.
Pillar I defines the capital an insurer
requires to remain solvent.
Pillar II defines the qualitative
aspects of the relationship between insurer and supervisor, for
example internal risk management processes, and aspects of operational
Pillar III addresses public disclosure.
Two thresholds are defined in Pillar I:
The highest is the Solvency Capital
Requirement (SCR). If an insurer's capital dips below this level,
a series of regulatory and/or supervisory interventions is triggered,
leading by stages down to the Minimum Capital Requirement (MCR).
Where the MCR is breached this is
likely to lead to swift, draconian supervisory action, for example,
preventing the insurer writing new business or seeking a transfer
of operations to a third party.
The Solvency II proposal also consolidates the
existing EU legislation on insurance regulation. However, only
the text on prudential regulation includes substantive changes.
The remainder of the text represents consolidation of existing
legislation and is not expected to be the subject of debate or
The key proposals welcomed by the industry across
Market Consistent Valuation of Assets and Liabilities
One of the most important aspects of Solvency
II is that it proposes a modern and sensible way of calculating
assets and liabilities that gives answers broadly consistent with
what the market would give. European insurers have long argued
for this approach to the valuation of technical provisions, and
it is a considerable benefit of the proposed new regime.
Effective risk management
Solvency II will require insurers to have, and
supervisors to review, good quality risk management across their
businesses. European standards in this area will help create a
common basis for supervision with common, robust protection for
European consumers. Accordingly, the Directive allows insurers
to calculate their capital (the Solvency Capital Requirement,
SCR) either by a standard, formula-based approach, or by using
an internal model, which must be individually approved by the
insurer's regulator. It will be crucial to ensure that model standards
are not unduly onerous as we would expect over time a significant
proportion of insurers would wish to seek approval to use either
a full or partial internal model for regulatory purposes.
Another major benefit of the current Directive
is the new approach to group supervision, which will particularly
benefit major insurance companies with operations in more than
one member state.The existing approach to supervising insurance
groups is based on considering the group as a collection of separate
legal entities, all supervised individually by their national
supervisor. This brings significant duplication of work for groups
operating across Europe and does not reflect the economic reality
of groups being increasingly managed centrally as a single entity,
especially within the EU. It also constrains the efficient use
of capital across the group.
European groups have long called for more streamlined
group supervision and greater freedom in capital allocationwe
believe the Directive is a significant step towards this goal.
The proposal must not be diluted if its benefits are to be realised.
Group supervision will mean that national supervisors
need to work more closely together. Regular information exchange
will be needed to ensure that the interests of both the group
supervisor and the local supervisor are fully taken into account.
Group supervision would have a significant impact
in the UK, where 21% of insurers authorised in the UK are foreign-owned.
Those headquartered in other EU member states might well expect
to be supervised for prudential purposes by their home state supervisor.
We also strongly support the intention to create
a principles-based solvency regime in Solvency II. This means
that detailed legislation is kept to an appropriate level, with
more opportunity for supervisors to amend and develop guidance
and practice in the light of experience. This will be a challenge
for Europe's regulators but it offers the prospect of a more flexible,
yet robust supervisory system for Europe's insurance companies.
However, there are a number of areas where further
work is needed:
Minimum Capital Requirement
As stated earlier, the Directive proposes two
main levels of capital requirements, the SCR and the MCR. There
is a strong case for calculating both the SCR and the MCR in a
similar way, using the "compact" approach. This method
sees the MCR set as a percentage of the SCR. If the MCR is calculated
independently, based on aggregation of individual risk modules,
the "modular" approach, the gap between SCR and MCR
becomes erratic, providing potentially conflicting signals to
the firm's management and to supervisors, which may create a tension
when considering the most appropriate response to a particular
stress event. It is also likely to lead to a MCR which is either
too low or much too high, as seen in the recent CEIOPS Quantative
Impact Study 3.
The Groups proposals are exciting and innovative
because they create a European framework for supervision. However,
for these proposals to work as intended, we need recognition that
capital held at the group level can be used to meet regulatory
capital requirements across the group. Whilst the "basic"
MCR would always be held locally in high quality capital, the
Solvency II proposals would see a much greater degree of capital
efficiency made possible, through the development of a common
framework for risk and capital management across Europe. This
is one of the most radical reforms contained in Solvency II and
presents the opportunity to break with the past where insurers
struggled with individual national requirements and instead introduce
a common and consistent approach across Europe. This will be essential
if we are to ensure there is a proper recognition of the diversification
of risks across a group.
Pillar 2Systems of governanceRisk
The current text on the risk management functions
is very prescriptive. This could be particularly damaging for
small and medium sized insurers, which often outsource or merge
some of the governance functions. Instead the framework directive
should be principles-based in this area and state outcomes, rather
than specifying how firms should achieve these outcomes.
Greater detail would be more appropriately placed
in Level 2 measures, delivered through common supervisory practices
across the EU.
Pillar 3Public disclosure
Better public disclosure is necessary for Solvency
II to work, primarily so that capital markets can better evaluate
the risk return features of a business, and price capital for
it accurately. In doing this, the market and supervisory actions
work to support each other. However, when it comes to public disclosure,
more isn't necessarily better.
For this reason it is crucial that the public
disclosure requirements are kept proportionate. For example, if
a firm is using an approved internal model, that should be the
basis for disclosure, rather than a standard approach that its
management is not using. Similarly, insurers need sufficient time
to submit and implement a recovery plan for breaches of the MCR
and SCR before they must be disclosed.
Thinking on third country regimes is fairly
embryonic in the current text. It will be important to find a
way for major European insurers to achieve diversification benefits
from their international operations by applying a Solvency II
calculation to them. Equally, where insurers from around the globe
are moving to a modern Solvency II like approach to supervision
and risk management then they should get supervisory recognition
of this in the EU, including in the calculation of capital requirements.
The Solvency II project is based on principles
agreed by the International Association of Insurance Supervisors.
Considerable interest in Solvency II is already evident in the
US and other developed and developing insurance markets.
Provided the broad outlines of the Commission's
proposal are supported in the European Parliament and the Council
of Ministers, the Solvency II project should deliver positive
benefits for policyholders, insurers and regulators alike:
For policyholders, it is vital that
capital requirements are set at the right level. Too high, and
they lead to unnecessarily high premiums; too low, and the risk
of default by the insurer becomes too great.
For insurers, the benefit lies in
efficient capital management. Regulatory risk assessment will
be aligned with internal management.
For regulators, the proposals for
group supervision are key to delivering benefits. Greater co-operation
between national regulators, and a clear set of procedures in
case of difficulty, will increase regulators' understanding of
the insurers in their jurisdiction.
We believe that Solvency II can deliver a world-class
regulatory regime which will enable European insurers to compete
effectively with overseas insurers in the international markets.