Ditching Old Habits
The European Commission understands
that the complexity and sophistication of risk management in
the insurance sector has outgrown the current scheme for
regulating. This alone is a quantum leap in
Nearly four years after the launch of the European Union
single market initiative, the Berlin Wall came tumbling down,
and the EU has been kicking down walls ever since. Its vision
is to create a single market for the 21st century by
eliminating country and regulatory barriers that slow down
trade among the EU members.
Part of its mission is to transform its financial services
sector into a modern, nimble industry able to compete globally.
To accomplish this task, the EU has embraced the idea that
regulation should boost competitiveness, not stifle it.
The latest in a series of bold initiatives is Solvency II.
After years of study, last summer the European Commission
adopted a comprehensive and far-reaching reform package that
will remove obstacles to an efficiently functioning insurance
and reinsurance market, while improving supervision. The
benefit, the EC says, will accrue to consumers, industry, the
EU economy and overall financial stability.
The Commission acknowledges that the complexity and
sophistication of risk management in the insurance sector has
outgrown the current scheme for regulating. This alone is a
quantum leap in thinking. The result is a big gap between how
insurers manage risk and how they are regulated.
Charles McGreevy, European Commissioner for internal markets
and services, says they learned from the old system “that
capital is not enough in ensuring the soundness of insurers.
What is needed is greater focus on the management of insurers
and the management of risks.”
To compound the regulatory challenge, member states often
add country-specific rules to the minimum standards that the EU
sets out. The lack of uniformity from country to country
distorts the single market and hinders competition. The result
is higher costs for insurers and consumers, which in turn
Solvency II introduces economic risk-based solvency
requirements across all EU member states. The total
balance-sheet approach takes into consideration both asset-side
risks and liability-side risks. The proposal expands the
definition of risk to include market risk (fall in
investments), credit risk (default on debt) and operational
risk (product liability or business interruption) in addition,
of course, to insurance risks. Insurers will be required to
hold capital against all these risks. They also will be
required to actively manage their risks by identifying and
measuring the potential for future exposures whether from a new
business plan or a catastrophic event.
There’s a competitive upshot to all this. The better a
company manages its risks and the more diversified it is, the
less capital it may have to ante up. Some predict the new rules
will drive consolidation as insurers strive for more
diversification of risks.
A new supervisory review process will allow regulators to
evaluate an insurer’s overall risk profile to determine
capital requirements and if it has adequate risk management and
governance systems in place for handling the “nature,
scale and complexity” of its business.
To streamline supervision of insurance groups operating in
more than one country, the plan calls for group supervision
from the home country. The home supervisor will coordinate
oversight with regulators in other jurisdictions. The approach
is to ensure that risks outside a supervisor’s
jurisdiction are not overlooked and that policyholders are
Of course, one important key to all this is good data.
Insurers will be required to disclose publicly far more
information than in the past.
The EU wants to create a solvency model for the world. Few
would question the need for global oversight of multinational
insurance entities. But the regulatory mindset has to
change. Jorgen Holmquist, the Commission’s director
general for internal market and financial services, brings home
the point: “We must ditch old habits.”