The three pillar approach

Solvency II is also based on a three pillar model similar to “Basel II” for banking supervision. 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 standards

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 would trigger an intervention by the supervisory authority if no longer met (“capital-based” insolvency avoidance).

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 standards

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 (“governance-based“ insolvency avoidance). They are 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
• 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. The second pillar 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 (“information-based” insolvency avoidance). Solvency II reporting that undertakings are required to submit to the FMA have been largely harmonised, 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.