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Solvency II

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On 1 January 2016 a fundamental reform in insurance supervision law entered into force with the introduction of Solvency II. In particular the own funds requirements (solvency regulations) for insurance and reinsurance undertakings are affected. The previously existing static system for the determining of own funds requirements was replaced by a risk-based system. Qualitative elements, such as, for example, internal risk management are required to be afforded stronger consideration. Under the new supervisory regime, it is intended to achieve greater harmonisation of supervision in Europe.

The protection of insured persons remains the main objective of insurance supervision in the Solvency II regime. The standards focus on a stronger risk-orientation and serve for the intensification of supervisory convergence, in order to prevent supervisory arbitrage. In accordance with the aim towards cross-sector convergence, the instruments for financial supervision were in particular designed in accordance with the model from the reform in the banking sector. Furthermore, the following can also be listed as aims:

  • To extend the existing system that was hitherto predominantly quantitative in nature by adding qualitative requirements: Since there is a relatively broad room for manoeuvre available to insurance and reinsurance undertakings with regard to the formation of their risk profile in the solvency capital requirement (pillar 1), it should be ensured in contrast, that the qualitative requirements for controlling the undertaking, the governance system, and internal processes etc. (pillar 2) are more intensively reviewed by the supervisory authority.
  • Strengthening of a risk-oriented supervision: The supervisory authority’s focus is intended to concentrate on the areas where there is the greatest risk potential; the supervisory means deployed should be proportionate to the extent at which the supervisory aims are placed in jeopardy.
  • Increasing transparency and accountability: The far-reaching disclosure obligations (pillar 3) benefit the comparability of the financial situation, solvency and the governance system of the individual insurance and reinsurance undertakings. Undertakings that apply model procedures or which have a risk-aware corporate governance, should be “rewarded” for this (at least that is the idea) by the addressees of the disclosure (i.e. the policyholders, insurance intermediaries, ratings agencies, investors and other market participants).
  • More efficient monitoring of insurance groups: By extending the tasks conferred on colleges of supervisors and strengthening the role of the supervisory authority for group-level supervision, it is intended to ensure that group-wide risks are not overlooked.
  • Aligning the new supervisory regime to international standards: The standards under supervisory law for valuation should as far as possible be harmonised with the international developments in accounting standards (International Accounting Standards (IAS))/(International Financial Reporting Standards (IFRS)), in order to ensure that the administrative burden for insurance undertakings and reinsurance undertakings is kept to a sensible level. Furthermore, the standards developed by the International Association of Insurance Supervisors (IAIS) and the developments in the field of actuarial mathematics have also been taken into account.

In a similar fashion to that of banking supervision law’s “Basel II” framework, Solvency II is also based on a three pillar model. The quantitative solvency requirements under pillar 1 are complemented by far-reaching qualitative requirements, forming pillar 2, as well as the element of market discipline in pillar 3:

Pillar 1: quantitative requirements

The Solvency Capital Requirement is either calculated by using a prescribed standard formula or by means of an internal (partial) model developed by the insurance and reinsurance undertaking. The minimum capital requirement forms a lower limit, which if underrun would trigger an intervention by the supervisory authority.

The first pillar also includes the regulations for drawing up a solvency balance sheet, which is generally based on market values. The eligible capital is derived on the basis of this balance sheet.

Pillar 2: qualitative requirements

The second pillar contains qualitative requirements, since Solvency II is intended to take into account all risks that are relevant for an undertaking, and not just the quantifiable risks which can be underpinned by means of own funds. Undertakings are required to establish a governance system. It is expected to have appropriate and transparent organisational structures with a clear allocation and delineation of competences as well as an effective system for transmitting information. The following governance functions are required to be established:

• risk management function

• compliance function

• internal audit function, as well as

• an actuarial function.

Guidelines and contingency plans must be drawn up and standards relating to the internal control system and the issue of outsourcing must be adhered to.

Within risk management an Own Risk and Solvency Assessment must be carried out. This includes undertaking forward-looking risk self-assessment.

Under Solvency II investments are required to be managed in accordance with the prudent person principle – legal standards for quantitative limits no longer exist.

Pillar 2 also covers requirements for the principles and methods of supervision. Particular attention is paid to the Supervisory Review Process.

Pillar 3: market discipline

The third pillar of Solvency II contains disclosure and reporting obligations. The Solvency II reports that undertakings are required to submit to the FMA have to a large extent been formalised, both with regard to the contents of the report as well as the reporting format.

The new comprehensive disclosure obligations are intended to increase transparency, by increasing the degree of comparability of information, reducing information asymmetries and by improving the information options for interested parties. Consequently corrective effects can be seen in the market, while the introduction of “good practices” is also being promoted.

The FMA is also required to meet comprehensive supervisory disclosure obligations on its website and to fulfil reporting obligations.

Work has been ongoing since the 1990s on improving (Solvency I) and restructuring (Solvency II) the EU solvency regulations.

In a first step the most necessary changes were made to the directives that existed at that time (Solvency I). These rules were in force in Austria from 1 January 2004 until 31 December 2015.

The following studies in particular proved influential with regard to the development of Solvency II:

Preparations for risk-based insurance supervision under (“Solvency II“) were underway at European level for several years. This page contains an overview of the milestones.

Here you can find information about:

  • Solvency I
  • Significant Studies on the Development of Solvency II
  • The key elements of Solvency II

Solvency I

Since the 1990s, the then Conference of European Supervisory Authorities worked on the improvement (Solvency I) and restructuring (Solvency II) of the EU regulations on solvency that had been introduced in 1973 for non-life assurance and in 1979 for life assurance undertakings. The Conference of European Supervisory Authorities’ Solvency I working group was established in 1994 under the chairmanship of the then Vice-President of the German Federal Insurance Supervisory Office, Helmut Müller, and published its concluding report in 1997, in which it was stated that the European solvency Directives had on the whole proven themselves. The report, however, also stated that the own funds regulations in place at the time did not adequately take all risks into account. It was therefore decided in 1997 to design a comprehensive system to create new own funds regulations.

In a first step the most necessary changes were made to the existing Directives (Solvency I). These rules entered into force on 1 January 2004 in Austria.

Significant Studies on the Development of Solvency II

The overhauling of the entire system was intended to only occur in a second stage. All such endeavours have been addressed by the keyword “Solvency II”.

The aim was to create a new European supervisory regime, which would equip the supervisory authorities with suitable qualitative and quantitative tools to be able to allow them to assess the overall solvency of an insurance undertaking in an adequate manner.

The previously applicable static system for determining the own funds base was to be replaced by a risk-based system – which also took into account qualitative elements.

The following studies in particular proved influential with regard to the development of Solvency II:

KPMG Study 2002
KPMG Deutsche Treuhand Gesellschaft was given the mandate by the commission to conduct a comprehensive investigation about the methodologies for the prudential supervision of the financial position of an insurance undertaking: “Study into the methodologies to assess the overall financial position of an insurance undertaking from the perspective of prudential supervision.”

Sharma Report
In July 2001, the Committee of European Insurance and Occupational Pensions Supervisors (CEIOPS, subsequently EIOPA) set up a working group with the aim of allowing national supervisory authorities to contribute towards the “Solvency II” project. The group investigated historic developments, reasons for the failure of insurance undertaking, as well as new trends with regard to the risk analysis of insurance undertakings.

On the basis of the findings of the aforementioned studies and other studies (by EU working groups, IAA – International Association of Actuaries, IAIS – International Association of Insurance Supervisors, and the KPMG study) it was decided to adopted a three pillar approach for Solvency II, similar to the design of Basel II but adapted to take into account various specificities of the insurance industry.

The key elements of Solvency II

  • Risk-based corporate governance and risk-based own funds calculation
  • Harmonisation and convergence in Europe
  • Basel II compatibility (where meaningful, certain techniques are also applied for insurance undertakings)
  • Changing from a rule-based system to a principle-based system (e.g. removing of strict rules, replaced by more flexible possibilities for intervention and more qualitative requirements).
  • Compatibility with International Accounting Standards
  • Three pillar approach:
    – Pillar I – Capital requirements
    – Pillar II – Governance rules
    – Pillar III – disclosure and reporting obligations

In order to offer Austrian insurance undertakings an opportunity to perform a self-assessment in relation to Solvency II, the FMA conducted a Self-Assessment in 2011.

This assessment process was intended to help the undertakings and the FMA alike to be able to gauge the current state of preparations for Solvency II. It was possible to determine in particular in which areas intentions had not yet been fully implemented or whether further action was required. The insurance undertakings were asked to fill out a qualitative questionnaire, with the result being as follows (using a 1-5 grading system (1 = the best grade; 5 = the worst grade):

  • General questions – 2.8
  • Governance system – 2.7
  • Investments – 2.7
  • Technical provisions – 3.1
  • SCR calculation using a standard formula – 2.5
  • Reporting and disclosure – 4.0

Furthermore sample contracts for life assurance and health insurance in accordance with Solvency II were evaluated and compared with current provisions. Undertakings that plan to use an internal model, were required to fill out an extended questionnaire.

The documentation relating to the self-assessment comprises of the following documents:

1. Self-Assessment

The excel file contains several worksheets that have been broken down thematically, with the assessment of the status of implementation of a Solvency II requirement being entered in the cells highlighted in yellow. It is important to note that the current status of implementation was asked for (cut-off point: 30 June 2011). It was therefore assessed to what extent the requirements in accordance with Solvency II had already been implemented.
The last two worksheets (with red tabs) were only to be filled out by those undertakings, that were planning to implement and internal full or partial model. The self-assessment was intended to reflect the current implementation status as precisely and comprehensibly.

2. Self-Assessment – additional answers

Five issues, that are specified in the questionnaire, were to be described in greater detail in this Word document.

3. Sample contracts for Life Assurance & results sheet

The FMA’s aim was to receive comparison values for three sample contracts. Every insurance undertaking was therefore requested to choose a contract from their portfolio, which as far as possible corresponded to the sample supplied. In the event that the undertaking did not have a “similar” insurance contract, then an existing contract was to be adapted in such a way that it matched the respective sample contract as far as possible.

4. Sample contracts for Health Insurance & results sheet

In this case the same principle applies as that mentioned for Life Assurance.

Further information: