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From Solvency I to

Solvency II

Prof. Karel Van HulleKU Leuven and Goethe University Frankfurt

Member IRSG – EIOPA

Serbian Insurance Days

Arandjevolac, 29 November 2017

Insurance regulation under Solvency I

• Was boring: very difficult to explain to an outsider how to

calculate the solvency margin under Solvency I

• Insurance regulation was highly prescriptive and

paternalistic

• Insurance regulation was very legalistic and did not reflect

the economics of the insurance business model

• Insurance regulation was more concerned with

policyholder protection than with insurance

• Insurance supervisors were considered less important or

qualified than their banking colleagues

Prof. Karel Van Hulle - KU Leuven

and Goethe University Frankfurt

2

Insurance supervision under Solvency I

• Insurance supervision was often limited to a detailed

scrutiny of a number of forms

• Form over substance – tick the box exercise

• Insurance supervisors rarely engaged directly with

supervised entities

• Insurance supervisors rarely had direct market experience:

employment moves between supervision and industry or

vice versa were often seen as suspect

• Insurance supervisors preferred detailed rules rather than

a principles based approach, requiring judgment



3

The birth of Solvency II

• For the EU, Solvency II is the most important change in

insurance regulation since the last 30 years

• The birth of Solvency II was very much helped by the

capital market crisis at the beginning of this century

• Crucial elements of Solvency II are:

o The introduction of an economic risk based approach

o The linkage between risk and capital

o The crucial role to be played by risk management

• The need to move in the direction of a risk based solvency

capital regime is now recognised throughout the world



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Why Solvency II?

• Solvency I as designed in the 70’s was not sufficiently risk

based

• Solvency I did not encourage insurers to better manage

their risks

• Solvency I did not attach sufficient importance to the

qualitative aspects of supervision

• Solvency I did not include an early warning signal

• Solvency I did not attach sufficient importance to group

supervision

• Solvency I did not take account of progress in banking,

accounting, actuarial science

Other reasons

• After 30 years, it was time to modernize the regulatory

framework for insurance

• Action was needed before the Solvency I regime would

break down because of a changed environment

• A more efficient allocation of capital would allow the

insurance industry to take on more risks

• Supervisory convergence could only come about when

moving away from minimum harmonization

• Recent changes in banking regulation could produce

regulatory arbitrage inciting insurers to engage in more

risky behaviour



6

Principle objectives of Solvency II

• Deepen the Single Market

• Enhance policyholder protection and financial stability

• Improve (international) competitiveness of EU insurers

• Further better regulation



7

Ways and means to achieve this

• Establishment of risk sensitive capital requirements to

encourage and reward good risk management

• Emphasis on the responsibility of senior management to

manage their business responsibly

• Fostering of greater supervisory convergence

• Institution of a regular dialogue between supervisor and

supervised entities



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Solvency II: 3 pillars and a roof

Pillar 1: quantitative requirements

1. Harmonised calculation of technical provisions

2. "Prudent person" approach to investments instead of

current quantitative restrictions

3. Two capital requirements: the Solvency Capital

Requirement (SCR) and the Minimum Capital Requirement

(MCR)

Pillar 2: qualitative requirements and

supervision

1. Enhanced governance, internal control, risk

management and own risk and solvency assessment (ORSA)

2. Strengthened supervisory review, harmonised supervisory

standards and practices

Pillar 3: prudential reporting and public

disclosure

1. Common supervisory reporting

2. Public disclosure of the financial condition and solvency

report

(market discipline through transparency)

Group supervision & cross-sectoral convergence

Groups are recognised as an economic entity=> supervision on a consolidated basis(diversification benefits, group risks)

Pillar I: Quantitative Requirements

• Market consistent valuation (fair value) of assets and liabilities

• Total balance sheet approach

• Two capital requirements: SCR with confidence level of 99.5% VaR over a one year time horizon and MCR with absolute floor

• Calculation of SCR based upon standard formula or an internal model (full or partial) approved by the supervisor

• No lists of eligible assets or limits on investments (Prudent Person Rule)

• Credit for risk mitigation (securitisation, derivatives, reinsurance) and for diversification



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Capital and technical provisions

• What is capital in an insurance undertaking? How to deal

with long term liabilities?

• Market consistent valuation of technical provisions: best

estimate and risk margin (based on cost of capital)

• Efficient allocation of capital

o Two capital requirements with supervisory ladder of

intervention

o SCR is target level of capital: no need to provide for

excessive capital (breach of SCR = invite for cup of tea)

o Capital is only one of the measures to ensure solvency



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• Qualitative requirements to cover risks which are not

covered in the SCR

• Enhanced internal control, governance and risk

management, as well as self-assessment of capital needs

(ORSA) with a forward looking approach

• Strengthened supervisory review, harmonised supervisory

standards and practices

Pillar II: Qualitative Requirements



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General governance requirements

• From implicit to explicit governance

• Effective system providing for sound and prudent

management

• Adequate and transparent organisational structure

• Clear allocation and appropriate segregation of

responsibilities

• Effective system for ensuring transmission of information

• Proportionality principle

• Persons in charge of key functions, members of the Board

and persons effectively running the business must be fit

and proper



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Governance functions

• General principles

o Written policy

o Prior approval by the Board

o Regular review (annually or in case of significant

changes)

• Key functions

o Risk management including ORSA

o Internal control and compliance

o Internal audit

o Actuarial



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Objectives of the ORSA

• ORSA should ensure that an insurer does not engage in

business for which it does not have sufficient capital

• ORSA should allow an insurer to assess the quality and

quantity of financial resources available to it, relative to its

needs

o NO SEPARATE CONSIDERATION OF RISK AND

CAPITAL

o ORSA IS THE DNA OF AN INSURANCE

UNDERTAKING

15Prof. Karel Van Hulle - KU Leuven


What should ORSA be?

• A continuous process to ensure that risk and solvency are

key factors in the insurer’s decision making

• A key component of an insurer’s risk management culture

• A project that is supported by all key stakeholders, based

on a clear plan and a clear allocation of responsibilities



What should ORSA not be?

• ORSA should not become a compliance reporting exercise

(no box ticking)

• ORSA should not be performed solely for the benefit of the

supervisor

• ORSA should not be seen or be used as a new capital

requirement

• ORSA should not replace regulatory capital requirements



Pillar III: Disclosure & Reporting

• Public disclosure and Supervisory Reporting

• New approach in Pillar 1 and Pillar 2 means new

approach needed for Pillar 3!

• More freedom for firms to run themselves; but with new

responsibilities new requirements for disclosure to

harness market discipline in support of achieving the

regulatory objectives = public disclosure

• Power and discretion for supervisors: need to earn trust

of stakeholders; need to foster supervisory convergence

& achieve competitive equality new requirements for

transparency = supervisory reporting



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Public disclosure

• The Solvency and Financial Conditions Report (SFCR) is

disclosed on an annual basis from May 2017 onwards

• The SFCR follows a prescribed structure:

o Description of business and performance

o Description and assessment of the adequacy of the

system of governance

o Risk profile

o Valuation for solvency purposes

o Capital management

o Summary



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Supervisory reporting

• Solvency and Financial Condition Report (annually)

• Regular supervisory report (at least every 3 years)

o Business and performance

o System of governance

o Risk profile

o Valuation for solvency purposes

o Capital management

• ORSA supervisory report (at least annually)

• Annual quantitative templates developed by EIOPA

• Quarterly quantitative templates developed by EIOPA

• Exemptions may apply for SMEs under certain conditions



20

Reinforcement of group supervision

• Identification and nomination of a group supervisor

• Rights and duties of the group supervisor for all key

elements of group supervision

• Enhancement of the duty to exchange information

• Full recognition of diversification benefits

• Internal model to calculate the group SCR

• Group ORSA and Group Solvency and Financial Condition

Report

• Subroups: maximum three levels of supervision



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Proportionality

• Account must be taken of the nature, scale and complexity of the operations of each (re) insurance undertaking. This means:

o Regime should not be too burdensome for small andmedium-sized undertakings

o Proportionality applies not only to the requirements imposed by law (three pillars) but also to the exercise of supervisorypowers

o Example: combination of governance functions

o Proportionality also means that if the operations of an insurance undertaking are complex, more stringent rules might have to be applied

o Proportionality is never about “if” but about “how”. The resultcan never be zero.





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Impact of financial crisis

• QIS 5 (2011) showed high volatility in the solvency capital

and in own funds as a result of market instability

• Volatility was caused by measurement of liabilities at

market value

• Difficulty to define a risk free discount rate to apply to the

valuation of long term liabilities

• Difference in life products between MS requires different

solutions to remove “artificial” volatility

• Transition from Solvency I to Solvency II was made difficult

because of the change in the discount rate

• Low interest rate environment

Omnibus II

• Directive 2014/51/EU of 16 April 2014:

o Amends the Solvency II Framework Directive (2009)

and the EIOPA Regulation (2011):

• Powers and responsibilities of EIOPA

• Organizes the implementation of the Framework Directive and

sets the date of first time application at 1 January 2016

• Proportionality (for instance, reporting obligations)

• Temporary and provisional equivalence (third country regimes)

• Long term guarantee package

• Phasing-in and transitional provisions

• Review clause (2020)



24

Omnibus II turns SII into a project in 4 stages

• Framework Directive containing the principles of the new

solvency regime adopted by Council and EP (level 1)

• Implementation of the Framework Directive by the EC

through a Delegated Act (Regulation): scrutiny of Council

and EP (from 3 to 6 months) (level 2)

• Regulatory and Implementing Technical Standards

developed by EIOPA which become legally binding after

endorsement by the EC (level 3)

• Guidelines / Recommendations developed by EIOPA

addressed to supervisors and/or insurers and which are

applicable on a “comply or explain” basis (level 4)



25

Commission Delegated Regulation

• Adopted on 10 October 2014 (300 p.)

• Based upon 76 empowerments in the Solvency II

Framework Directive as amended by Omnibus II

• Prepared on the basis of a formal Call for Advice sent to

EIOPA in March 2009

• Advice provided to the EC (Nov. 2009 - Jan. 2010)

• Draft prepared by EC and consulted upon in the course of

2010-2011 and amended after adoption of Omnibus II

• Legal form of Commission Regulation (single rulebook)

• Sets first review date for standard formula in 2018



26

Early lessons from Solvency II

• Insurers and insurance supervisors have difficulties to

work with a principle based approach

• Insurance supervisors look at the SCR as the MCR!

• Insurers are developing strategies to optimize capital

• EIOPA stress tests show that most insurers are well

capitalised

• Risk management of most insurers has improved

• Insurance and insurance regulation/supervision is taken

more seriously (also by banking supervisors)

• Supervisory colleges are playing an important role in

furthering a single European rulebook



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Role of EIOPA

• EIOPA as technical adviser to the EC and to the EP with

leadership role for technical issues concerning insurance

supervision (RTS and ITS)

• EIOPA now represented in all (92) colleges of supervisors

• EIOPA responsible for developing common supervisory

culture

• Binding mediation, peer reviews

• Cooperation with ESRB

• Clear mandate to further develop market conduct rules

• Assisted by two stakeholder groups (IRSG and OPSG)

EIOPA tools for supervisory convergence

• Guidelines and recommendations

• Monitoring of implementation in practice

• Supervisory colleges

• Supervisory handbook

• Peer reviews

• Bilateral engagements with national competent authorities

• Balance sheet reviews

• Country reviews

• Technical assistance

• Binding mediation



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Concluding remarks

• Solvency II puts more emphasis on the responsibility of

each individual undertaking

o Investment strategy (prudent person)

o Asset-Liability management

o Governance functions

o Own risk and solvency assessment

• Solvency II recognises the strength and the weakness of

human nature: more focus on risk management and

governance

• Solvency II cannot work without a change in management

and supervisory culture



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Prof. Karel VAN HULLE

Research Center Insurance

Faculty of Economics and Business

KU Leuven

Naamsestraat 69 Box 3525, B-3000 Leuven

[email protected]

International Center for Insurance Regulation

Faculty of Economics and Business Admin.

Goethe University – House of Finance

Th.-W.-Adorno-Platz 3, D-60629 Frankfurt/ Main

[email protected]

mailto:[email protected]

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