Infosys-Oracle Blog

After formation of European Union the regulators introduced Solvency I framework which was used to monitor the Solvency of Insurers operating within EU. Solvency I was based on simple factors and formulas and was easy to implement. However with time it was known that the Insurers were facing many dynamic Risks from there day to day operations and simple calculations of Solvency could not meet the Risk which an Insurer was exposed to. It was decided to move from formulae based approach of Solvency to a Risk based approach and Solvency II framework was introduced.

Solvency II is the set of regulatory requirements for Insurance companies operating in European Union (EU). It is the proposed new legislation which will govern the capital requirements of Insurance companies within EU. Solvency II aims at setting revised guidelines for capital requirements and improves the Risk management Standards for Insurers. Capital requirements for insurers will be directly dependant on the Risk underwritten by the Insurers which in turn will be derived from consistent principals and models.

The proposed Solvency II framework has 3 main areas (pillars):

Pillar 1 is about Quantitative requirements which measure the amount of capital Insurers should hold. It measures the financial position and capital adequacy of Insurers by valuing its assets, liabilities and Capital.

Pillar 2 is focused on enhanced supervisory review of various processes adopted by Insurers. It sets out requirements for governance, control, Risk management and solvency self assessment of insurers.

Pillar 3 focuses on disclosure and transparency requirements. It consists of public disclosure of financial condition and solvency reports.

The following objectives explain the importance of Solvency II and why it should be adopted across the European Union by all Insurers:

1. To protect the interest of policyholders in European Union by ensuring the financial stability of (re)insurance companies.
2. To replace the age old Solvency I framework which was introduced in early 70s which defined capital requirements by blanket solvency margins which were quite simple in design and did not always reflected the true risk in a given portfolio of Insurance business.
3. To adopt Risk-based solvency system by aligning capital requirement of each insurer to the underlying Risk which it is exposed to.
4. The aim is not only to define capital requirement but it also requires companies to establish systems, processes and controls for Risk Management.
5. Use of Company specific internal model to calculate capital requirement encourages insurers to develop the risk management practices internally to correctly estimate the underlying risk.
6. To encourage increased focus on internal governance including identification, measurement, monitoring and control.
7. The set of regulatory legislations aims at providing a level playing field for all insurers within European Union irrespective of its legal form, size or location.
8. To improve the competitiveness of European Union Insurers both within EU insurance market and internationally by removing unnecessary regulatory constraints and adopting common set of rules for all.
9. To achieve consistency across European Union on key ideas like: Risk based capital allocation, Own Risk and Solvency assessment, higher accountability of senior management, higher Supervisory control and transparent reporting & disclosures.
10. Solvency II is based on principles and not rules so it provides an opportunity for Insurers in EU to really embed the principles into their corporate governance and culture so that business could be done in a more better and transparent way.

If you are aware of Solvency II and its importance then please do share your thoughts as part of comments to the blog.