CEA sees room for improvement in Solvency II

European insurance industry body the Comité Européen des Assurances
(CEA) has released what it termed “high-level comments” on the
European Commission’s draft Directive on Solvency II for European
insurers, published in July. Praising the EC’s initiative, which is
aimed at introducing sweeping changes to the way insurers manage
risk and are supervised in 2012, CEA president Gérard de La
Martinière said: “European insurers believe that the Solvency II
proposal is an important milestone in the supervision of insurers
and reinsurers, not only in Europe but also worldwide.”

In its broad comments, the CEA said European insurers welcomed the
underlying risk-based economic approach in Solvency II because “it
encourages sound risk management practices and improves
policyholder protection by allowing internal models, recognition of
risk mitigation techniques – such as reinsurance or securitisation
– and diversification effects”.

Despite its general praise for the EC’s initiative, the CEA
highlighted areas it regards as in need of further
consideration.

One area is inconsistency between two proposed capital
requirements, the Solvency Capital Requirement (SCR) and the
Minimum Capital Requirement (MCR). An insurer falling below the SCR
would be required to correct the capital shortfall within six
months. The MCR is a target level sufficient to cover all
one-in-200-years events. Falling below the MCR will trigger
immediate supervisory intervention.

“Consistency between both capital requirements is an essential
prerequisite for insurers to take adequate measures and to enable
supervisors to operate the escalating ladder of supervisory
intervention approach, which is central to Solvency II,” said de La
Martinière.

CEA believes the MCR should be expressed as a percentage of the SCR
in order to ensure that the two targets are based on the same
risk-oriented principles and move in the same direction in adverse
circumstances.

The CEA raised another concern related to the SCR. The new solvency
system regime proposed by the draft directive effectively treats
the SCR as what the CEA termed “a hard solvency control level” and
will require insurers to hold capital in excess of the SCR in order
to maintain a buffer to absorb short-term volatility. If the
effective capital requirement (the SCR plus buffer) is set at a
relatively high level, the CEA warned that “it could force
companies to de-risk”. For example, companies could reduce their
equity exposure, something the CEA believes could be detrimental in
the long term to policyholders in terms of premium rates and/or
benefit levels.

The CEA also called for further attention to supervisory
requirements. The CEA said that while it supports supervisors
having the powers they need to fulfil their obligations, it was
“concerned by the wide-ranging and open-ended nature of the powers
available to supervisors and the potential lack of harmonisation on
some aspects of the current proposal”.

As an example of the proposal’s open-ended nature, the CEA cited
proposed own risk and solvency assessments (ORSA) by insurers. It
noted that the directive does not require ORSA implementing
measures to be developed and as a result it was “quite likely” that
different supervisors would develop “significantly different
practices and requirements in this regard”.

To overcome its concern, the CEA proposed that the introduction of
any new regulatory powers and harmonisation of existing ones should
include detailed guidance as to the extent and circumstances under
which the powers would be expected to be exercised. It is
important, added the CEA, that supervisors are “consistent in their
actions and decisions, including consistent application of the
supervisory powers made available across different countries,
different companies and over time”.

Tiered resources

The CEA was also critical of another draft directive proposal that
requires an insurer’s financial resources to be assigned to one of
three tiers. According to professional services firm
PricewaterhouseCoopers, the tiers are based on a range of criteria
including availability, permanence and efficacy in absorbing
potential losses and are classified as high, medium and low
quality.

“The extent to which financial resources within these tiers are
eligible to meet a company’s capital requirements are subject to
restrictions,” noted the CEA. “This is inconsistent with an
economic approach and as such the industry does not support having
artificial limits (such as arbitrary percentages) on the capital
available to protect policy-holders.”

Concluding its assessment of Solvency II, the Comité Européen des
Assurances said: “We look forward to working with all stakeholders
to complete the development of the directive and associated
implementing measures in a timely manner.”