October 19th, 2011

Timeline: Transitioning to Solvency II

Posted at 1:00 AM ET

As is often the case with pan-European legislation, the implementation timeframe for Solvency II has generated a great deal of debate and discussion - and what had been a firm January 2013 go-live date now looks increasingly unlikely. It appears at this point that the new regulations will be phased in, and enforcement is likely to be postponed by a year. Such a delay would buy some welcome time for companies that are behind in their Solvency II preparations - but is being opposed by others who say it will add more costs to an already expensive preparation process.

Solvency II is being developed under the European Union’s (EU) Lamfalussy process(1). The different stages of this process have been managed by the Committee of European Insurance and Occupational Pensions Supervisors (CEIOPS, now known as EIOPA, for European Insurance and Occupational Pensions Authority), which has met with the different stakeholders and developed recommendations. These recommendations are then reviewed by the European Commission (EC), which has the authority to define the final principles, and — based on recent discussion — is set to enforce the directive in January 2014.

Alongside this, companies and regulators are heavily engaged in digesting Solvency II’s fifth Quantitative Impact Study (QIS 5). This was the last in a series of test studies used to develop the standard formula, which will be the basis for determining the solvency capital requirement (SCR) for EU (re)insurers. The results were released in March 2011, and while they provided valuable insight on the complexity and challenges of the Solvency II effort, they also generated a good deal of debate.

solv-ii-fig-3

More recently, EIOPA published the findings of a second wave of stress tests for insurers. Although the results overall showed the insurance sector to be robust, 10 percent of insurers failed to meet the minimum capital requirements (MCR) in one of its scenarios. This was much more of an issue given that the stress levels were criticized for not being particularly stressful. The 13 (2) companies that failed were thought to be smaller firms, and this has led to the expectation that merger and acquisition (M&A) activity may increase close to implementation.

It is worth noting, however, that Solvency II calibrations are yet to be finalized and may lead to less onerous capital requirements than those used in the stress test. The Solvency II standard formula may still impose stringent capital requirements on some firms, though under QIS 5, for example, Lloyd’s would be required to hold GBP10 billion additional capital, even under a more lenient calibration.

Whatever the final implementation timeframe, companies need to address several key issues to ensure that they are ready for Solvency II. These may include building and documenting a (partial) internal model that is embedded within the entity’s ERM framework, to meet the use test requirements.

While the debate is far from settled, it is likely that the implementation of Solvency II will be executed transitionally. Among the recommendations of the 2011 Omnibus II directive is a call for a phased rollout. As shown in Figure 4, Omnibus II proposes a number of areas where the EC may adopt transitional measures and sets out the maximum duration of those measures.

solv-ii-fig-4

Moody’s Investors Service called the Omnibus II proposals “broadly credit positive” for the European (re)insurance sector, allowing a smooth transition to the new Solvency II regime that avoids market disruption. Still, the transitional approach should benefit smaller companies in particular, as they will likely face the biggest challenges in fully meeting the new solvency capital requirements in January 2014. The Omnibus II proposals buy them more time - in some areas, up to 10 years.

As with much related to the Solvency II implementation, Omnibus II is still a topic of active discussion, and it is by no means settled.

Notes:
1 The Lamfalussy Process is an approach to the development of financial service industry regulations used by the European Union. The four-level process includes the following - Level 1: Framework principles; Level 2: Implementation measures; Level 3: Guidance regarding day-to-day supervision; Level 4: Enforcement.

2 InsuranceERM.

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