October 28th, 2008

Solvency II Compliance Advantage Derives Returns

Posted at 6:00 PM ET

Eddy Vanbeneden, Managing Director

Compliance may be an expense, but it can still generate a return. The increased cost of operating a European carrier has become a major aspect of Solvency II preparations, preventing many from seeing this regulation as a business opportunity. An enhanced understanding of the specific risks in a portfolio can lead to improved capital management, robust margins, and benefits to shareholders. Instead of pursuing compliance, (re)insurers should look for the competitive advantage that the regulation affords.

Solvency II is expected to come into force in 2012, with the objective of protecting policyholders and the stability of the global insurance system. Risk-based capital (RBC) requirements are at the regulation’s core, and carriers will have to show a 99.5 percent likelihood of solvency for the coming 12 months.

Solvency II offers three methods for determining the general solvency capital requirement (SCR). Carriers can use an approved full-scale internal model, a partial internal model, or a standard formula. Further, according to the latest Quantitative Impact Study (QIS Draft 4), carriers can either use geographic or line of business variations of a standard formula for calculating their SCRs for non-life catastrophe charges, or take a custom approach, using internal or proprietary models approved by their respective supervisory authorities

With the internal approach, carriers can base their SCRs on their specific portfolio risks. Where this requires a larger SCR, the result is greater discipline and protection from the risk of insolvency. When the use of approved internal models results in a lower SCR, though, carriers can make the additional capital productive.

A unique opportunity results from the third SCR calculation alternative: competitive compliance. (Re)insurers can use the specific risks in their portfolios to determine how much capital they need to address the perils they cover. Guy Carpenter’s simulation platform MetaRisk®, for example, offers a robust alternative to standard Solvency II calculations, accounting for underwriting, market, credit, and operational risk—to gauge the SCR accurately.

Solvency II can be a compliance initiative or a capital management opportunity. The choice resides with the carrier. If you elect to use an approved proprietary model instead of the standard SCR formula to ascertain specific risk levels,  the capital you free may return many times over.

Guy Carpenter & Company, LLC provides this text for general information only. The information contained herein is based on sources we believe reliable, but we do not guarantee its accuracy, and it should be understood to be general insurance/reinsurance information only. Statements concerning, tax, accounting, legal or regulatory matters should be understood to be general observations based solely on our experience as reinsurance brokers and risk consultants, and may not be relied upon as tax, accounting, legal or regulatory advice which we are not authorized to provide.  All such matters should be reviewed with your own qualified advisors in these areas.

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