Solvency II
Encyclopedia
The Solvency II Directive 2009/138/EC is an EU Directive that codifies and harmonises the EU insurance regulation. Primarily this concerns the amount of capital that EU insurance
Insurance
In law and economics, insurance is a form of risk management primarily used to hedge against the risk of a contingent, uncertain loss. Insurance is defined as the equitable transfer of the risk of a loss, from one entity to another, in exchange for payment. An insurer is a company selling the...

 companies must hold to reduce the risk of insolvency
Insolvency
Insolvency means the inability to pay one's debts as they fall due. Usually used to refer to a business, insolvency refers to the inability of a company to pay off its debts.Business insolvency is defined in two different ways:...

.

Once the Omnibus II directive is approved by the European Parliament, Solvency II will be scheduled to come into effect on 1 January 2013.

Aims

EU insurance legislation aims to unify a single EU insurance market and enhance consumer protection. The third-generation Insurance Directives established an "EU passport" (single licence) for insurers to operate in all member states if they fulfilled EU conditions. Many member states concluded the EU minima were not enough, and took up their own reforms, which still lead to differing regulations, hampering the goal of a single market.

Background

Since the initial Solvency I Directive 73/239/EEC was introduced in 1973, more elaborate risk management
Risk management
Risk management is the identification, assessment, and prioritization of risks followed by coordinated and economical application of resources to minimize, monitor, and control the probability and/or impact of unfortunate events or to maximize the realization of opportunities...

 systems developed. Solvency II reflects new risk management practices to define required capital and manage risk. While the "Solvency I" Directive was aimed at revising and updating the current EU Solvency regime, Solvency II has a much wider scope. A solvency capital requirement may have the following purposes:
  • To reduce the risk that an insurer would be unable to meet claims;
  • To reduce the losses suffered by policyholders in the event that a firm is unable to meet all claims fully;
  • To provide early warning to supervisors so that they can intervene promptly if capital falls below the required level; and
  • To promote confidence in the financial stability of the insurance sector


Often called "Basel for insurers," Solvency II is somewhat similar to the banking regulations of Basel II
Basel II
Basel II is the second of the Basel Accords, which are recommendations on banking laws and regulations issued by the Basel Committee on Banking Supervision...

. For example, the proposed Solvency II framework has three main areas (pillars):
  • Pillar 1 consists of the quantitative requirements (for example, the amount of capital an insurer should hold).
  • Pillar 2 sets out requirements for the governance and risk management of insurers, as well as for the effective supervision of insurers.
  • Pillar 3 focuses on disclosure and transparency requirements.

Contents

Title I General rules on the taking-up and pursuit of direct insurance and reinsurance activities
  • Ch I Subject matter, scope and definitions
  • Ch II Taking-up of business
  • Ch III Supervisory authorities and general rules
  • Ch IV Conditions governing business
  • Ch V Pursuit of life and non-life insurance activity
  • Ch VI Rules relating to the valuation of assets and liabilities, technical provisions, own funds, solvency capital requirement, minimum capital requirement and investment rules
  • Ch VII Insurance and reinsurance undertakings in difficulty or in an irregular situation
  • Ch VIII Right of establishment and freedom to provide services
  • Ch IX Branches established within the community and belonging to insurance or reinsurance undertakings with head offices situated outside the community
  • Ch X Subsidiaries of insurance and reinsurance undertakings governed by the laws of a third country and acquisitions of holdings by such undertakings


Title II Specific provisions for insurance and reinsurance

Title III Supervision of insurance and reinsurance undertakings in a group

Title IV Reorganisation and winding-up of insurance undertakings

Pillar 1

The pillar 1 framework set out qualitative and quantitative requirements for calculation of technical provisions and Solvency Capital Requirement (SCR) using either a standard formula given by the regulators or an internal model developed by the (re)insurance company. Technical provisions comprise two components: the best estimate of the liabilities (i.e. the central actuarial estimate) plus a risk margin. Technical provisions are intended to represent the current amount the (re)insurance company would have to pay for an immediate transfer of its obligations to a third party. The SCR is the capital required to ensure that the (re)insurance company will be able to meet its obligations over the next 12 months with a probability of at least 99.5%. In addition to the SCR capital a Minimum Capital Requirement (MCR
MCR
- Music :* Modena City Ramblers, an Italian folk rock band* My Chemical Romance, an American rock band* Middle Class Rut, an American rock band- Organisations :* Maryport and Carlisle Railway, a pre-gouping British railway company...

) must be calculated which represents the threshold below which the national supervisor (regulator) would intervene. The MCR is intended to correspond to an 85% probability of adequacy over a one year period and is bounded between 25% and 45% of the SCR.

For supervisory purposes, the SCR and MCR can be regarded as "soft" and "hard" floors respectively. That is, a regulatory ladder of intervention applies once the capital holding of the (re)insurance undertaking falls below the SCR, with the intervention becoming progressively more intense as the capital holding approaches the MCR. The Solvency II Directive provides regional supervisors with a number of discretions to address breaches of the MCR, including the withdrawal of authorisation from selling new business and the winding up of the company.

External links


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