Download Solvency 2

European Parliament Financial Services
Forum
Solvency 2
Summary

1:
Solvency 2 is an important piece of legislation for the European Economy

2:
Solvency 2 will be a political success under specific conditions

3:
Consequences of an uneconomic supervision would be heavy for all
stakeholders

4:
The present draft and preparation process give a preliminary view of strengths and
weaknesses of the project at this time

5:
Strong political orientations must be given by the legislator
European Parliament Financial Services Forum Solvency 2– Denis Duverne – 08/05/07 - 2
Solvency 2 is an important piece of legislation for
the European Economy
 Solvency 2 addresses two different objectives:
 To protect policyholders from the Insurance Industry’s insolvency; and
 To ensure an economic optimum for all the stakeholders of the Insurance Industry
 Consumers
 Employees
 Public Authorities
 Investors.
 Both objectives are compatible because Solvency 2 brings more security which is:
 vital for the Policyholders; and
 compatible with an economic optimum for all stakeholders of the Insurance
Industry.
 It will directly impact many aspects of the European Economy as much as the Insurance
Industry. Therefore it implies a strong political involvement in order to ensure that the
interests of all stakeholders are taken into account.
 The Insurance Industry fully supports Solvency 2 as:
 it will foster innovation; and
 the European market might gain a decisive competitive advantage
European Parliament Financial Services Forum Solvency 2– Denis Duverne – 08/05/07 - 3
Solvency 2 will be a political success under specific
conditions

Capital requirements are based on an Economic basis.
It means an optimal price/coverage ratio for insurance products resulting in:
 the maximisation of the volume of risks transferred from individuals and businesses to
insurers with more security for a given amount of capital immobilised; and
 a larger capacity for insurers to take risk and more appetite for innovation.

New risk mitigation techniques (hedging, securitisation, hybrid capital, risk assessment based
on internal models, etc) are recognised.
This would allow the Insurance Industry:
 to transfer more risks to financial markets with more capacity for the Insurance Industry
to absorb risks from Society (e.g environmental risks); and
 To leverage product innovation to meet consumer and social needs (in pensions,
health).

Risk diversification (lines of business, markets, etc) is fully taken into account.
For a given amount of risk, diversification will reduce regulatory capital requirements with
positive impact for the competitiveness of the Insurance Industry, shareholders, employees and
customers.

The supervision is driven at the Group level. It relies upon:
 a full harmonisation of solvency rules and standards at the European level; and
 a lead supervisor and enhanced cooperation/coordination between supervisors.
European Parliament Financial Services Forum Solvency 2– Denis Duverne – 08/05/07 - 4
Consequences of an uneconomic supervision would be
heavy for all stakeholders

Solvency 2 reform would be severely endangered with
 Excessive capital requirements;
 Short-sighted view of the calibration of equity risks;
 Ignorance of cutting-edge risk management and financial innovation;
 Limitation of transnational diversification benefits; and
 Large flexibility given to local supervision to “gold-plate” the directive with local
regulations.

Solvency 2 failure would have incommensurate consequences compared to a remote risk of
insolvency of the European Insurance Industry. Main risks are:
 For Society: a shortage of coverage when the gap between public capacity and demand
for protection is increasing (Pension, Health, long term care, professional liability,
environmental risks, etc).
 For individuals: increased prices, under-insurance or lack of coverage.
 For the Insurance Industry: lack of innovation, job losses, domination by non-EU groups.
 For the financial markets: shortage of long term holders of assets which would prejudice
long term protection needs (pension) and innovation.
 Europe as a single market not becoming a reality.
European Parliament Financial Services Forum Solvency 2– Denis Duverne – 08/05/07 - 5
The present draft and preparation process give a
preliminary view of strengths and weaknesses of the
project at this time (1/3)
The drafting of the directive by the European Commission has led to a broad and effective
consultation process with the Insurance Industry.
In line with the Lamfalussy procedure, most of the main technical components of the Solvency 2
reform are managed separately from the directive through the Quantitative Impact Studies
(QIS) exercise. The QIS are used to experiment and refine the calibration of solvency
requirements.
The QIS exercise creates more discomfort. It follows a different timetable. There is no validation
process between the successive steps and it is not clear how lessons learned from one QIS are
reflected in the next round of QIS.
Despite some improvement in the 3rd round of QIS there are still many uncertainties which
should be resolved to avoid a gap between the satisfactory orientations of the directive and its
application.
European Parliament Financial Services Forum Solvency 2– Denis Duverne – 08/05/07 - 6
The present draft and preparation process give a
preliminary view of strengths and weaknesses of the
project at this time (2/3)

Strengths of the directive:
 Solvency 2 follows a risk based economic supervision approach;
 Solvency 2 will favour the development of high quality risk management;
 The Group supervision is regarded as the relevant level for solvency assessment and
supervision. Subgroups are not relevant; and
 Focus on group Solvency Capital Requirement (SCR) under the responsibility of the
lead supervisor. Group diversification is taken into account while local capital level is
allowed to move lower than local SCR. Difference between local capital level and local
SCR is provided by Group support.

The main uncertainties are related to group issues
 A too high Minimum Capital Requirement (MCR), supervised at the local level, would
strongly reduce the benefits of diversification and related possibility of Group support.
Ideally MCR should be calculated as a percentage of the SCR and not in a modular
approach.
 The possibility offered to the local supervisor to ask to the Group a formal external
guarantee is hazardous in many ways : transfer of risks, availability and costs…
 Possibility of quantitative restrictions concerning eligible assets at national level
European Parliament Financial Services Forum Solvency 2– Denis Duverne – 08/05/07 - 7
The present draft and preparation process give a
preliminary view of strengths and weaknesses of the
project at this time (3/3)

Very good dialogue between the Industry and the Commission resulted in some improvements
in QIS 3:
 Level of equity charge lowered from 40% to 32%. Adjustment of correlations between
equity and bonds;
 Possibility to modulate capital charge in function of duration (13% over 10 years); and
 Lowering of calibration for Health business.

But there is still a lot to worry about over the outcome of the QIS:
 Calibration of P&C risks induces a steep rise in requirements. Total requirements for
motor insurance, a low volatility business, would be at 26% of premiums in QIS 3. For
long-tail risks, this impact is much higher.
 SCR calculation is only based on European entities. It will penalise European Groups
against international competition.
 Calibration of real estate remains at a high level (20%).
 Introduction of spread risk (in QIS 2 only default risk was considered), much higher than
Basel II.
 Technical provisions are calculated with a market value margin (MVM) calculated using
a cost of capital approach. This is the right approach. But if capital requirements are set
too high, the MVM (and consequently provisions) will be too high.
 No account taken of the diversification effect between lines of business.
European Parliament Financial Services Forum Solvency 2– Denis Duverne – 08/05/07 - 8
Strong political orientations must be given by the
legislator

European Parliament should give clear political mandates to the supervisory authorities.
Without strong political guidance, there is a risk that the CEIOPS goes beyond its role of
“technical advisor” to the Commission for the level 2 to impose an excessive prudential
approach which will deeply distort the political content of the reform and may negatively impact
the customers.

The following elements, of political importance, should be defined at the directive level:
 A full harmonisation of the level of confidence, i.e. capital requirements, including
procedure for exceptional add-ons, eligible capital, investment rules;
 A strong guidance on the overall level of requirements, which should be unchanged
compared to Solvency 1, in terms of capital surplus;
 The process of Group and solo supervision, defining a clear split of responsibilities, and
focusing on consolidated approach for Group;
 The full recognition of Group diversification;
 Specific guidance on key political issues, such as the treatment of equities;
 Detailed methodology to calculate standard SCR and MCR; and
 Definition of a cap to the MCR (i.e. MCR < x% of SCR).

Level 2 implementation measures are of major importance and should be closely followed by
political stakeholders, as it is often the case for Lamfalussy directives (MiFid).
 The directive should not be applicable until a consensus is reached concerning the
implementation measures, especially calibration.
European Parliament Financial Services Forum Solvency 2– Denis Duverne – 08/05/07 - 9
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