March 2nd, 2017

Solvency II: Greater Risk-Driven Management: Part I

Posted at 1:00 AM ET

andrew-cox-95eagle_matthew-smeddy-vanbeneden-sm21 Andrew Cox, Managing Director; Matthew Eagle, Head of GC Analytics - International and Eddy Vanbeneden, Managing Director

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On January 1, 2016, the Solvency II regulatory regime took effect. Some celebrated; others were weary from the months and years of preparation.

But, to borrow a turn of phrase from Winston Churchill, this is not the end of Solvency II, it is not even the beginning of the end, but it is the end of the beginning.

The impact of Solvency II goes well beyond its strict regulatory assessment. Solvency II creates an environment for greater risk-driven management of the (re)insurance companies doing business in and with Europe.

While the solvency capital requirement (SCR) and minimum capital requirement are the thresholds used by regulators to trigger action on specific entities, the solvency ratio (own funds over SCR) is fast becoming an important metric for comparing companies.

Today, many companies publish their solvency ratios without being required to do so, and some others actually specify target solvency ratio ranges as part of their risk appetite and financial targets.

Solvency ratios are another metric for investors to use when assessing the relative financial strength of companies - and (re)insurance buyers can do the same when assessing counterparty risk.

Some larger quoted companies use the capital regime to strengthen their self-regulation. By setting target ranges and minimum levels well above 100 percent, these companies create their own parameters for self-intervention in instances when they will buy back shares or simply cut the dividend. We have seen examples of companies recapitalizing after their SCR moved below a minimum range, illustrating the focus investors may start to have on this metric.

However, the effectiveness of a single ratio as the basis of comparisons should not be overstated. For example, how comparable is a standard formula-based ratio to one calculated on an internal model? What about different use of transitional arrangements, or matching adjustments? As Solvency II is still being introduced at different rates, various stakeholders have to pay attention to individual company standards for reporting solvency ratios.

Link to Part II>>

Link to Part III>>

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