Frank Achtert, Managing Director, Financial Intelligence Team, and Sebastien Portmann, Vice President, Financial Intelligence Team
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On April 15th, 2010, the European Commission (EC) published its draft technical specifications for the next Quantitative Impact Study (QIS) 5, which will be implemented from August to November of 2010. Based on empirical evidence, the general calibration of the standard formula solvency capital requirement (SCR) may fall between the calibration of QIS 4 and the calibration seen in the rigid proposals of the various consultation papers (CP) submitted during 2009. This article takes a deeper look at the calibration of non-life underwriting risk as part of the overall SCR calculation.

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Financial Intelligence Team
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Solvency II compliance should provide more opportunity than burden … if executed properly. The ability to use approved internal models results in a Solvency Capital Requirement (SCR) that’s tailored to the risks in your portfolio - which in itself is advantageous. This benefit translates into more effective capital management, as it reflects the risks you actually cover (rather than the output of a standard formula). Improved operations through the internal model approach may also free capital for deployment elsewhere — if the model-determined SCR is lower than that from the Solvency II standard formula. The newly available capital can be invested in any number of initiatives that can lead to a competitive advantage.

After the jump, you’ll find five ways to attain competitive compliance.

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Frank Achtert, Managing Director, and Eddy Vanbeneden, Managing Director
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Group support will not be permitted when Solvency II becomes effective in 2012. As a result, the flexibility to use capital held anywhere in the group in calculating the Solvency Capital Requirement (SCR) will not be available. Rather, each entity will have to calculate its SCR based on the capital it has, regardless of its group’s position as a whole. This last-minute change to eliminate group support could prompt some European insurance groups to change their structures - or at least rethink how much risk they will take in each entity.

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Henry Keeling, President and CEO of Guy Carpenter’s International Operations
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The emerging consensus seems to be that Solvency II will cost a lot and make the (re)insurance business more complicated. If conventional approaches to regulatory compliance are applied, this is likely to be true. After all, compliance tends to be seen as just another expense. This does not have to be the case for Solvency II, however. Choosing the right approach could free capital for investment elsewhere, ultimately resulting in a competitive advantage. “Competitive compliance,” consequently, can create an upside where most would perceive only a cost to be managed.

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David Lewin, Managing Director
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Legislation consisting of five directives on motor insurance that was adopted by the European Community (EC) is widely perceived as a major contribution to the free movement of vehicles (and thus individuals and goods) within the European Union. The first three directives, adopted between 1972 and 1990, established a single market in the field of motor insurance and required all motor vehicles to be covered by third-party liability insurance. Moreover, the directives abolished the inspections previously conducted at EU internal border points to verify civil liability insurance for motor vehicles. The fourth of the five Motor Insurance Directives adopted by the European Parliament (Parliament) and Council of the European Union (Council) in 2000 focused on “visiting victims,” i.e., people who have had accidents outside their EU Member States of residence. The directive streamlined claim and compensation procedures and provided for the quicker settlement of claims. The latest Motor Insurance Directive in 2005 modernized the provisions contained in the previous directives on motor insurance and took steps to further protect victims.

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Financial Intelligence Team
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CP31 sets out the principles an entity must adhere to in order to allow the recognition of financial mitigation techniques (e.g., financial derivatives) for Solvency Capital Requirement (SCR) purposes. It states the capital requirement should allow for an appropriate reduction to reflect the mitigation techniques in place while avoiding allowing deductions based on inappropriate mitigation techniques.

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Financial Intelligence Team
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Each (re)insurer’s system of governance should:

• Establish and maintain effective cooperation, internal reporting and communication at all relevant levels.
• Have a clear, consistent and documented organizational structure.
• Establish, implement and maintain decision-making procedures
• Establish information systems that produce sufficient and relevant information concerning all business activities and risks to which the entity is exposed.
• Establish and maintain adequate risk management, compliance, internal audit and actuarial functions.

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Financial Intelligence Team
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Introduction

When Solvency II becomes effective in 2012, group support — which would have allowed capital held at the group level to cover the requirements of any company in the group — will be not permitted. This prohibition will require group entities to hold capital according to the Solvency Capital Requirements (SCR) in each individual entity. The application of group-level diversification benefits to individual entities will not be allowed. This last-minute change to the original framework directive may cause some groups to change their structures. At a minimum, they are likely to rethink how much risk capital will be carried at the group level versus the operating entity level given that the risk capital needed in the group will increase without recognition of group support.

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Financial Intelligence Team
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In its series of Consultation Papers on Level 2 Implementing Measures for Solvency II, CEIOPS drafted a new proposal for the calculation of counterparty credit risk. While Consultation Paper 28 (March 2009) gives a general overview of the proposal, the more recent Consultation Paper 51 (July 2009) provides insight into the details of the model.

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The European Parliament approved the proposed Solvency II directive on Wednesday. The EU’s Economic and Financial Affairs Council is expected to adopt the framework by May 5, 2009, with the measure likely taking effect in 2012.

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