October 20th, 2011

Solvency II Timeline: The QIS 5 and Stress Test Results, Driving the Delay

Posted at 1:00 AM ET

A great deal of attention this year has been focused on determining the practical effects of Solvency II once it is put into effect. In March 2011 the results of QIS 5 were released. EIOPA launched a three-month Solvency II stress test shortly thereafter. Both events shed light on the real-world implications of the new regime, raised issues that should be addressed before it goes into effect and, in large part, sparked the debate that is likely to lead to a delay in its implementation.

According to EIOPA , the QIS 5 results show that the financial position of the European insurance and reinsurance sector assessed against the SCR of the Solvency II directive is sound. The participation rate was 68 percent, with all 30 EU and European Economic Area (EEA) countries taking part. Companies that participated in QIS 5 hold EUR395 billion of adjusted excess capital above their SCR, and adjusted excess capital of EUR676 billion above their minimum capital requirements (MCR), as defined in the Solvency II directive. Ninety-two percent of capital was classed as “highest quality possible.”

EIOPA further stated that this confirmed the strong position of the insurance sector, since the capital surplus was reached despite a difficult market situation. However, the exercise showed a reduction of (re)insurers’ capital surplus (the amount of eligible own funds over capital required) of 44 percent, or EUR86 billion, compared to the calculation under Solvency I. The QIS 5 report asserts that this effect would be largely absorbed if insurance groups apply internal models and transitional measures to calculate the Solvency II capital requirements, limiting the reduction of the surplus to EUR3 billion, which represents roughly 1 percent.

Like much around Solvency II, the QIS 5 results produced a spirited debate between industry participants and administrators over its methodology and implications. This has led EIOPA to identify areas where further guidance seems necessary and where the feasibility and complexity of the Solvency II proposals should be addressed to ensure proper implementation. This is especially true for small and medium firms. These areas include the design of the non-life and health catastrophe risk sub-modules, the definition of contract boundaries and related valuation of deferred taxes and expected profits in future premium. The discussion has also raised other important topics not tested in the exercise but requiring further industry attention, including governance, risk management and reporting requirements.

The QIS 5 exercise was followed by a Solvency II stress test carried out among all EU and EEA members and the Swiss Financial Market Authority between March 2011 and May 2011. The test modeled the prospective Solvency II capital requirements - the MCR in particular - under three scenarios: a market deterioration mirroring the one seen between September 2008 and September 2009, a more-adverse scenario assuming a prolonged recession, and a scenario assuming an increase in inflation followed by rapid interest rate hikes by central banks.

The results were generally encouraging. EIOPA concluded in its summary presentation that “overall, the European insurance sector remains robust.” 90 percent of the insurers met the proposed MCR under the most adverse scenario. Failure rates in the baseline and inflation scenarios were nine and eight percent, respectively. Participation in the stress test was strong. The exercise was completed by 58 groups and 71 companies representing approximately 60 percent of gross premium income of the European insurance market.

The results of the stress test were published in July 2011. While a preliminary review of the results shows them to be generally positive, we expect there to be ongoing discussion as they are further examined and digested by the market.

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