Europe and beyond for Solvency II
Solvency II – a regulatory regime for insurance organizations within the European Union – went “live” at the beginning of 2016, but both regulators and firms are still getting to grips with its requirements.
However, the impact of the new rules is much broader than just Europe. The International Association of Insurance Supervisors, a global group comparable to the Basel Committee of insurance regulators, has already begun to implement key portions of Solvency II worldwide.
Solvency II aims to achieve consistency of risk and regulatory capital management across Europe and includes the following key ideas:
- Market-consistent balance sheets
- Risk-based capital
- Forward-looking assessment based on Own Risk and Solvency Assessment (ORSA)
- Senior management accountability
- Supervisory assessment.
Understanding Solvency II
Insurance organizations in Europe must implement all three Pillars of Solvency II:
Pillar 1 - covers the financial requirements that Solvency II imposes. It specifies how the capital requirement is set and assessed, and how the eligible capital resources of the firm are determined. Pillar 1 is designed to ensure that a firm is adequately capitalized to deliver policyholder protection.
Pillar 2 - imposes higher standards of risk management and governance on firms. ORSA requires a firm to undertake its own forward-looking assessment of its risks, solvency needs, and adequacy of capital resources.
Pillar 3 - aims for greater levels of transparency for supervisors and the public. There is a private annual report to supervisors, as well as a public solvency and financial condition report. These reports contain core information that firms provide on a quarterly and annual basis.
Looking at look-through reporting
Solvency II requires European insurance organizations to report the underlying assets that make up the funds in which they invest, so that their regulatory capital requirements can be calculated under Pillar I and reported under Pillar III. This “look-through approach” is supposed to help insurers manage and assess their risk, especially the risks embedded in investment funds. The riskier the underlying securities or assets, the higher the capital charge they will attract.
The amount of detail in look-through reporting requirements varies under Pillar I and Pillar III. However, in some cases – when completing quarterly and annual quantitative reporting templates (QRT), for example – insurers will be expected to provide security-level detail.
While look-through reporting is a regulatory requirement under Solvency II, it strongly supports an insurance company’s overall risk management approach because it should give a full picture of investment and accumulation risks. This increased transparency can help insurance companies make strategic business and capital allocation decisions.
Diving deeper into ORSA
The Own Risk and Solvency Assessment (ORSA) is at the heart of Pillar II and the Solvency II approach in Europe. The framework has also been incorporated into the International Association of Insurance Supervisors (IAIS) list of Insurance Core Principles – in essence, ORSA has gone global.
Essentially, ORSA is an internal assessment of the risks associated with an insurer’s strategic business plan that determines whether it has the capital resources to support these risks. The board and senior management are required to take responsibility for ORSA, which must encompass all reasonably foreseeable and relevant material risks. It is very much like an enterprise risk management framework because an ORSA must be forward-looking and must assess risk and capital resources.
It is expected that most major jurisdictions will have an ORSA-like approach implemented by the end of the decade.
Regulatory Data Solutions
An infographic showing which countries are implementing the Own Risk and Solvency Assessment (ORSA) framework set by the International Association of Insurance Supervisors (IAIS) or a related ORSA framework.
Prior to the 2008 global financial crisis, regulators with oversight of the insurance industry saw little need for comprehensive risk assessments. Insurance firms were considered to have predictable long-term liabilities and saleable assets.
Solvency II will impact not only insurance companies but also the whole of the buy side chain, with an emphasis on asset servicers (investment managers, custodians and fund administrators).
Compliance with the Solvency II regulation requires insurers to review their data governance, sourcing and management processes.
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