Dubbed “the forgotten pillar,” (1) as it tends to get attention fairly late in a company’s Solvency II preparation process, Pillar Three deals with reporting requirements - to regulators and the public.
Two primary types of regular disclosure are required under Pillar Three: a report to supervisors (RTS), which provides information to regulators necessary for supervision of the company, and a solvency and financial condition report (SFCR ), a disclosure intended for public consumption. Each consists of an extensive qualitative report as well as quantitative reporting templates. There are also provisions for required reporting during specific predefined events or a regulatory inquiry. Figure 1 summarizes these requirements.
While insurance entities are well accustomed to extensive disclosure reporting, the Pillar Three requirements represent a significant new burden. Companies responding to EIOPA’s Consultation Paper 58 (CP 58), where these requirements are set out, have argued that the quantitative templates are overly cumbersome and detailed, particularly for smaller entities.
The qualitative reports, too, will be a challenge for companies. The bar has been set high: CP 58 requires that: “the level and depth of information to be publicly disclosed shall be based on the principle that a knowledgeable person can get a reasonably good understanding of the design and operational details of the internal model as well as to the reliability of the internal model.”
While repurposing elements from other required reports, such as financial statements, will be allowed, divergent accounting models will make this difficult in some cases. Carriers will need to disclose the differences in accounting methods used for Solvency II and other financial reporting until the directive and the International Financial Reporting Standards (IFRS) are more closely aligned.
The use of mark-to-market practices may be particularly problematic for carriers complying with Pillar Three. The view of mark-to-market under Solvency II is at odds with the majority of accounting practices in Europe, creating a reporting gap that will likely lead to additional disclosure and reporting effort. However, the current accounting regulations for insurance contracts under IFRS (referred to as “IFRS Phase 4″) use a “fair value” approach similar to that used in Solvency II. The challenge is the differences in some accounting results - for example, regarding the measurement of reserves and recognition of profit. Currently, there is a lack of clarity as to how (re)insurers and regulators will deal with these inconsistencies.
Like the rest of the Solvency II directive, the communications requirements of Pillar Three are a significant new administrative burden on market participants. It is imperative that companies not forget about this pillar in their Solvency II preparations.
1. PwC, The Forgotten Pillar: Time to bring disclosure onto the radar, April 2010