solvency ii from a u.s. perspective - vincent...

Insurance issues and insights from Howard Mills

Solvency II from a U.S. perspective

Forward FocusWinter 2011

In the world of insurance regulation, pressure continues to mount for the United States to adopt global standards. As worldwide networks continue to grow and expand, cross-border transactions have increasingly become the standard for doing business. Even insurers who do all of their businesses in the U.S. are not immune as calls arise for modernization and harmonization of insurance regulations and standards across borders.

For the insurance industry, nowhere is this phenomenon more apparent than in the area of solvency modernization. With the recent financial turmoil serving as an impetus for the development of tools that enhance risk awareness, capital standards, corporate governance, and disclosure and transparency, the race toward a uniform global solvency framework is on, via the European Commission’s Solvency II Directive (the “Directive”).

Aimed at improving and enhancing the existing insurance solvency regulation regime for the European Union’s (EU) 27 member states, the Directive moves away from old formulas to be more risk-based in nature and better aligned with current economic realities. Essentially, the Directive asks insurers to put their money where their risks are by enhancing the amount of capital companies have in place to cover unanticipated events.

To get there, Solvency II adopts a three-pillar approach similar to Switzerland’s Basel II for banking. With group supervision and cross-sectoral convergence serving as the “top hat” of the framework, the three underlying pillars address: Quantitative requirements, including capital requirements, harmonization of technical provisions, and a prudent approach to investments (Pillar 1); qualitative requirements and supervisions, including enhanced governance and a strengthened supervisory review (Pillar 2); and prudential reporting and public disclosure (Pillar 3).

The development and evaluation process of Solvency IIrequirements are divided into four levels, under the Lamfalussy process, an approach to the development of financial service industry regulations by the EU, named after Alexandre Lamfalussy, who chaired the EU advisory committee that created it in 2001. This process is composed of the first level, which was adopted in April 2009, and sets the legislative framework for Solvency II. The following three levels involve development of implementing measures, development of guidelines and common standards, and enforcement by the European Commission in ensuring cooperation between member states, regulators, and the private sector.

Executive summary

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Even insurers who do all of their businesses in the U.S. are not immune as calls arise for modernization and harmonization of insurance regulations and standards across borders.

Forward FocusHoward Mills


And while Solvency II’s roots are grounded in the EU, insurers globally expect to realize the Directive’s impact. In the U.S., insurance companies will feel its effects to varying degrees when Solvency II is entered in force on the expected target date of January 1, 2013. Initially, U.S. subsidiaries with parent companies in the EU will realize impacts in areas ranging from capital position and enterprise risk management (ERM) to new product development and other strategic areas. In the longer term, impacts will be seen throughout the U.S. industry as even U.S.- domiciled companies work to enhance their risk cultures and to shore up their ERM information technology capabilities to keep pace with industry leading practices and rating agency expectations.

Beyond the EU member states, outside jurisdictions or “third countries,” stand in line to gain Solvency II “equivalence,” based on the regulatory capital standards demanded by those jurisdictions, among other factors. And while the first wave of jurisdictions to be assessed for the possibility of achieving equivalence – Bermuda, Switzerland, and Japan – has been determined, the U.S. has been granted a provisional equivalence standing that will allow regulators here time to put the pieces in place prior to the Solvency II launch date at the start of 2013.

To this end, the National Association of Insurance Commissioners (NAIC) and the International Association of Insurance Supervisors (IAIS) in Switzerland are each working on frameworks and standards that share similarities with Solvency II in terms of emboldening regulatory oversight. While the IAIS aims to see global convergence come into play, the NAIC seeks to learn from other jurisdictions and use those best practices to improve the U.S. regulatory regime.

To be sure, there is much work to be done in readying for the eventuality of Solvency II. With the implementation deadline looming, leading insurance companies and their representatives are now at the table as the Directive is taking shape. Knowing that the complexities and culture changes required by Solvency II will clearly affect companies based in the U.S., prudent companies are working hard to understand the implications on the risk management framework in addition to the mammoth matrix that is found within Solvency II’s three pillars and four implementing measures. Knowledge is power, and now, more than ever, as we see our global community broadening to an extent heretofore unknown, insurers who are out in front at the table with the framers of Solvency II will maintain competitive advantage by keeping ahead of the curve on developments and proactively tackling solvency-related changes as they emerge.

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Before Solvency II, there was Solvency I, which dates to the early 1970s and is hinged on the concept of providing a standard for monitoring insurance company capital. Over time, it became apparent that Solvency I wasn’t quite meeting the mark that regulators had hoped. According to the Commission1, it became evident that Solvency I was too narrow in scope and lacked the ability to paint an overall view of how an insurance company was doing. Solvency II’s roots began with the July 2004 publication of the Commission’s “Framework for Consultation,” which gave the Commission’s Committee of European Insurance and Occupational Pension Supervisors (CEIOPS)2 guidelines to assist in answering calls for advice regarding the new solvency system.

The effort to launch Solvency II was born out of a wish to get a better handle on current insurance market developments, risk management, international financial reporting, and prudential standards, among other aspects. At its core, Solvency II represents and demands a tremendous change in a company’s overall risk management and risk culture, requiring of that culture a strong link between decision making and quantitative risk measurement. For companies that implement appropriate risk management systems and have on hand sound internal controls and the ability to measure and better manage their risk situation, there is a potential for a reduction in capital requirements.

The basic architecture of Solvency II is based on Basel II for banking in that it adopts a three-pillar approach, with each pillar representing a different regulatory component. The three regulatory components include: Pillar I, which demonstrates sufficient financial resources; Pillar II, which lays out an adequate system of governance; and Pillar III, which involves public disclosure and regulatory reporting requirements.

Solvency II from 30,000 feet up

1 “Background to the Solvency II Project,” European Commission, December 2010. Retrieved from: http://ec.europa.eu/internal_market/insurance/solvency/background_en.htm2 CEIOPS was replaced by European Insurance and Occupational Pensions Authority (EIOPA) in January 2011, in accordance with the new European financial supervision framework.

At its core, Solvency II represents and demands a tremendous change in a company’s overall risk management and risk culture.


How is Solvency II structured? The three pillars

Solvency II is based on three guiding principles (pillars), which cut across market, credit, operational, insurance, and •liquidity risk.

The new system is intended to offer insurance organizations incentives to better measure and manage their risk situation, •leading to lower capital requirements and lower pricing.

The new solvency system will include both quantitative and qualitative aspects of risk, with each pillar focusing on a •different regulatory component, including minimum capital requirements, risk measurement, management, and disclosure.

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The three pillarsPillar I: • Applies to all firms and considers key quantitative requirements, including “own funds” (available capital), technical provisions and calculating capital requirements (via the Solvency Capital Requirement (SCR)), and the Minimum Capital Requirement (MCR), with the SCR calculated either through an approved full or partial internal model, or though the standard formula approach. Both the SCR and the MCR provide an early indicator to regulators and insurance companies as to whether or not action needs to be taken. Further, under the Directive, an insurer may opt to calculate the capital requirements using the standard formula set by the supervisor or to adopt its own internal model to reflect specific risks faced by the organization. If the latter approach is adopted, the company must meet a series of tests for the model and get approval from the regulator who would be receiving the results. Currently, the trend appears to be that larger companies are choosing to create their own internal models rather than take the standard model route.

Pillar II: • Requires demonstration of an adequate system of governance by including an effective risk management system and prospective risk identification through the Own Risk and Solvency Assessment (ORSA). What’s important to note on ORSA is that all insurers will be required to produce one, regardless of whether they are working by their own internal model or by the standard model. In either case, if a regulator believes a

company’s ORSA falls short, the regulator will have the ability to impose higher capital requirements. That the regulator has the ability to impose capital add-ons in other instances gives companies an incentive to produce a robust and deeply embedded self analysis. Indeed, of all the pillars, Pillar II is likely the most challenging in terms of implementation as it mandates what for many companies will be a broad overhaul of the risk culture that will reach all levels of the company.

Pillar III: • Centers on public disclosure and regulatory reporting requirements. More specifically, Pillar III compliance requires two reports: The Report to Supervisor (RTS), which contains narrative and quantitative information that is provided to the supervisory authority and kept confidential, and the second, a Solvency and Financial Condition Report (SFCR), which is expected to be made publically available. These reports mean that we will be seeing companies interpreting the disclosure requirements, developing strategies for disclosure, and educating key stakeholders on the results. Clearly, the responsibility will be on companies to design the information, which, through public disclosure, will not only be available to regulators but to financial analysts, rating agencies, and all other stakeholders. In addition, compliance will mean that companies must develop the internal processes and systems needed to produce said reports within the required time frames.

Liquidity Risk

Insurance Risk

Market Risk

Credit Risk

Operational Risk

Solvency II

Pillar I

Quantitative Requirements

Capital Requirements

Valuation of Assets and Liabilities

Own Funds

Pillar II

Qualitative Requirements & Rules on Supervision

Regulations on Financial Services Supervision

Own Risk and Solvency Assessment (ORSA)

Capabilities and Powers of Regulators, Areas of

Activity

Pillar III

Supervisory Reporting and Public Disclosure

Transparency

Own Risk and Solvency Assessment (ORSA)

Disclosure Requirements

DisclosureQuantification Governance

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The Directive is intentionally principles-based so as to avoid the need to involve parliaments in changes to guidance. Therefore, the development and evaluation of the Solvency II implementation process has been divided into four levels in accordance with the Lamfalussy process. The first level of the process was adopted April 22, 2009, following many years of deliberation between the European Commission, the European Parliament, and the European Council. Development of Level 2 implementing measures has been ongoing for several years and has included five quantitative impact studies so far. To conduct the studies, industry uses draft implementation guidance to perform the calculations and then shares the feedback and results.

The most recent quantitative impact study, QIS5, was launched by the European Commission in July 2010. Under the supervision of CEIOPS, insurers and reinsurers have completed their participation in this impact study as of November 2010. The latest impact study is meant to

gather information on quantitative impact, appropriateness of technical specifications, preparedness of companies and supervisors, and dialogue between companies and supervisors.

While, as of this writing, the results of QIS5 have not been released, QIS4 was completed in the summer of 2008, and had 1,100 companies participate, or more than one-third of the entire European insurance market. With 351 life insurers and 227 composite insurers participating, results showed that the majority of life companies participating reported having a lower solvency ratio as compared with the current country-specific Solvency I requirements.

Meanwhile, finalized Level 2 and Level 3 guidance are due to be released thoughout 2011, as the countdown for continued work marches on toward the 2013 implementation date – though the chance of a delay is not out of the question.

The four-level Solvency II implementation process

What is it?

What does it include?

Who develops?

Who decides?

Level 1 Solvency II Directive Overall framework principles

European Commission

European Parliament and Council of Ministers

Level 2 Implementing measures

Detailed implementation measures

European Commission

European Commission, but with consent of EIOPC and European Parliament

Level 3 Supervisory standards Guidelines to apply in day-to-day supervision

CEIOPS CEIOPS

Level 4 Evaluation Monitoring compliance and performance

European Commission

European Commission

The four-level Solvency II implementation process



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How IFRS plays into the mix

With Solvency II aimed to be in force in 2013, insurers who also have their eye on International Financial Reporting Standards (IFRS) may realize some challenges as 2013 also marks the year when the number of countries adopting IFRS is expected to increase.

The good news is that Solvency II was developed with IFRS in mind and is meant to be largely compatible with the new accounting standards. That said, the framers of IFRS and the International Accounting Standards Board (IASB) in the UK are still working with the Financial Accounting Standards Board (FASB) in the U.S. to finalize the insurance contracts section, IFRS-4. Here, divergence is taking place between contract liability requirements and Solvency II technical provisions.

This discord is expected to add to the challenges for insurers as they adopt the measures. While liabilities are expected to be largely based on the same concepts, there is the potential for material differences to exist in items, such as discount rates and contract unbundling. Also likely to be at issue are differences in the definition, calibration, and amortization of the margins used.

The impact of Solvency II on U.S. InsurersAs mentioned previously, Solvency II is due to be entered in force on January 1, 2013. That date may seem far off for some. However, proactive companies are undergoing implementation preparations now, given the complexity of the analysis involved and the significant requirements at hand. And, indeed, Solvency II demands are to be embedded throughout the organization for use in decision making.

Aside from the tremendous amount of effort companies are expending in readying for Solvency II, insurers and reinsurers are thinking ahead in terms of the likely impact the Directive will have once in place.

In the shorter term, the primary impacts of Solvency II will be felt by U.S. subsidiaries with parent companies located in the EU. These impacts will span the spectrum, from a firm’s capital position, ERM program, and product strategy, to its resources, risk culture, and technology.

More specifically, these companies, like their parents abroad, will be required to provide MCR and SCR calculations and must meet Pillar II requirements in regard to risk management practices and structure, including an ORSA, which lays out a company’s risk management and risk identification systems.

For subsidiaries whose EU parents have chosen the internal model route, the subsidiaries will also need to demonstrate that the results of their own internal models are used as a basis in making broad business decisions, including pricing, underwriting, performance measurement, and executive compensation. Not an easy task.

Those who fit under this category are realizing now the breadth and depth of Solvency II a good two years before the Directive is slated to take effect. Indeed, as a result of the requirements, companies have been spending hundreds of millions of dollars in participating in deep-dive exercises, such as quantitative impact studies and in-house preparation activities. At present, many insurers and reinsurers in the U.S. and other third countries have recently completed QIS5 dry runs, while EU member states have submitted preapplications to the Financial Services Authority (the regulator of the financial services industry in the UK) to use their own internal models in completing the job.

In addition to impact study participation, the Solvency II to-do list for many companies also includes planning for capital adequacy, risk management, and disclosures, all of which will become a part of strategic decisions going forward.

In the longer term, impacts on risk culture are expected to increase, with business performance and day-to-day decision making to be based on a risk-adjusted basis, with risk exposure being monitored against risk appetite. A very significant impact will also be seen in the area of technology, as transformation of the risk function comes into play, demanding new architecture that is capable of providing an automated, timely, “fit for purpose” risk analytics for use in strategic decision making.

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Capital Position

Continued higher requirements for EU subs•Ripple effects on U.S. industry through NAIC Solvency •Modernization Initiative (SMI) and rating agencies

ERM Framework

Roles, responsibilities, and accountabilities are clearly •defined and align with desired risk takingRisk and control frameworks are embedded, including •risk assessment and quantification

Product Strategy

Competitive advantage emerges for U.S. companies on •certain product types (e.g., fixed annuities)Increased focus on product diversification•

Resources

Continued demand for resources with broad risk and •capital analysis understandingPotential for efficiency gains due to process •improvements

Risk Culture

pre-applications

Business performance and day-to-day decision making is •based on a risk adjusted basis with risk exposure being monitored against appetiteIndividuals incentivized to act in a manner consistent •with risk strategy

Technology

Transformation of risk function architecture for all •major players to allow for automated, timely, and “fit for purpose” risk analytics for use in strategic decision making

Impact of Solvency II on U.S. companies

In the longer term, significant overall industry implications are expected:

Low impact High impact


Capital Position

Continued higher requirements for EU subs•Ripple effects on U.S. industry through NAIC Solvency •Modernization Initiative (SMI) and rating agencies

ERM Framework

Roles, responsibilities, and accountabilities are clearly •defined and align with desired risk takingRisk and control frameworks are embedded, including •risk assessment and quantification

Product Strategy

Competitive advantage emerges for U.S. companies on •certain product types (e.g., fixed annuities)Increased focus on product diversification•

Resources

Continued demand for resources with broad risk and •capital analysis understandingPotential for efficiency gains due to process •improvements

Risk Culture

pre-applications

Business performance and day-to-day decision making is •based on a risk adjusted basis with risk exposure being monitored against appetiteIndividuals incentivized to act in a manner consistent •with risk strategy

Technology

Transformation of risk function architecture for all •major players to allow for automated, timely, and “fit for purpose” risk analytics for use in strategic decision making

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Generally speaking, the U.S. industry falls into three categories with respect to the view on solvency standards. The first category is composed of U.S.-domiciled companies that may have subsidiaries in line to be affected by Solvency II; the second is the multinational company that has a broad mix of business that will benefit from Solvency II diversification; and the third is the multinational firm that has a narrow mix of business, in particular those with heavy reliance on asset-intensive business.

While there are many challenges for all in connection to Solvency II, opportunities abound as well. These include the potential for reduced capital under certain approaches for certain projects and gaining a better understanding of

current risk and capital exposures and sensitivities. Also placed in the opportunities column is an enhanced and integrated governance and risk management view across the spectrum of a company’s business units.

Solvency II also allows for a fully integrated and standardized risk process and methodology across an organization, including enhanced capital efficiency and deployments across multiple entities, and increased consistency between internal views and decisions on risk and regulatory risk requirements.

For U.S. companies, getting there is another story.

U.S. domiciled

May have subsidiaries impacted by Solvency II•

Generally against significant revisions to U.S. capital requirements•

Likely to see competitive benefit if U.S. regime does not change materially and equivalence •is not reached

Longer-term secondary implications due to rating agency and (ultimately) U.S. •regulatory changes

Multinational

with broad

business mix

Impacted by Solvency II•

Endorse and currently use a market consistent approach in decision making•

Generally for revisions to U.S. capital requirements, in particular, a movement to a •market-consistent approach in “leveling the playing field”

Understand negative ramifications if equivalence is not reached, and in some cases •already revising product strategy to mitigate impact

Multinational

with specific

business mix

Impacted by Solvency II•

Generally in favor of revisions to U.S. capital requirements, in particular, a movement •to a full principles-based approach to capital if it can be used as a basis for equivalence under Solvency II

Likely to face significant and extreme competitive pressure and capital increases under •Solvency II requirements without equivalence

U.S. company views on Solvency II

In general, the U.S. industry falls into three categories with respect to current views on solvency standards:

Achieving Solvency II equivalence for the U.S. In a presentation3 Karel van Hulle gave at the 2010 annual meeting of the IAIS in Dubai, United Arab Emirates, Mr. van Hulle, head of unit at the European Commission’s Directorate-General Internal Market and Services office, outlined the European Commission’s position on third countries. He said that the commission has the ability to make binding decisions regarding the equivalence of third countries’ group and reinsurance supervision. Where a third country is deemed to have equivalent standards, EU supervisors will rely on the supervision applied in that country and insurance and reinsurers from that third country will be treated in the same manner as EU insurers and reinsurers, Mr. van Hulle said.

Simply stated, the concept of equivalence relates to rules within Solvency II that lay out traits and characteristics which a third country must have in place in order for the capital standards of outside regimes to be deemed equivalent to Solvency II. Built into the Solvency II framework is an implementation timetable that provides for consultation by CEIOPS on the criteria to assess third country equivalence. This will be followed by discussions with the third countries concerned, leading to a final decision on the issue by the European Commission aimed for June 2012. Efforts to set criteria for equivalence span back to December 2009, when CEIOPS issued its first consultation on the topic, detailing technical criteria that would be used in assessing third country equivalence.

Activity on the equivalence issue has been brisk in the past few months. In the U.S., the issue has been a priority at the NAIC, whose members have been in discussions with the EU since 2009. Most recently, the issue bubbled up at the IAIS meeting in Dubai, where regulators announced it was likely that the U.S. would receive “provisional” equivalence approval from CEIOPS.

Not many days following its conclusion of the October IAIS meeting, the European Commission announced it would not include the U.S. in the first wave of countries to be assessed in the areas of reinsurance, group capital, and group supervision. However, the European Commission followed that announcement by revealing it had developed a transitional regime by which third countries that meet certain criteria would be treated the same as countries that receive a positive equivalence finding. According to a October 19, 2010 public letter from the European Commission to CEIOPS, the U.S. is a prime candidate for the transitional regime. As such, the U.S. must “commit to converging towards a solvency regime capable of meeting the equivalence assessment criteria by the end of the transitional period,” according to the letter.4

For the most part, the insurance industry in the U.S. is happy to see the U.S. be included in the Solvency II transitional regime; however, insurance trade associations such as the Property Casualty Insurers Association of America (PCI) urge regulators in the U.S. to use caution in moving ahead. In its November 3, 2010 International Bulletin5, PCI said it would encourage the NAIC “not to be pressured to adopt changes in order to achieve an equivalence finding.” It also noted that, while PCI supports equivalence, U.S. insurance regulators should not feel pressured to produce new layers of regulation in order to increase the chances of an ultimate and final equivalence finding.

If the U.S. fails to achieve full equivalence standing, competitive issues are likely to result between U.S.-domiciled companies and U.S. subsidiaries of EU parents, as the former will develop and price products with a view toward statutory capital requirements and the latter will be required to consider market-consistent Solvency II capital requirements for their products and pricing.

3 “Solvency II: the end of the beginning; Solvency II Information Seminar,” Dubai, October 26 2010, Prof. Karel Van Hulle 4 Letter dated October 29, 2010, to CEIOPS Chairman Mr Gabriel Bernardino from Jonathan Faull, Director General for Justice,

Freedom and Security at the EU Commission5 “U.S. May Be Included in ‘Transitional Measures, Not in “First Wave,” Property Casualty Insurers Association of America,

International Bulletin, November 3, 2010

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Related activities at the NAIC and IAIS Aside from the various positions of particular insurance companies, the prospect of moving toward Solvency II equivalence for the U.S. is something that is top of mind at the NAIC. Not seeking full-fledged regulatory convergence with Solvency II, the NAIC is nevertheless staying involved on the global regulatory front and placing its energy on what it views to be a strong, multijurisdictional system of state-based regulation that has existed in the U.S. for over 100 years.

Conversely, the IAIS, which boasts a membership of at least 190 global regulatory jurisdictions, is working to put the bricks in place to pave the way toward a regulatory coming together of the world’s insurance jurisdictions.

Solvency modernization at the NAICIndeed, the NAIC is not seeking to be lock-step with Solvency II. Rather, it argues that the state-based system of insurance regulation – particularly the U.S. Financial Accreditation System overseen by the NAIC – has proven its worth through the financial crisis with the U.S. remaining as a jurisdiction with one of the highest premium volumes in the world. However, there’s always room for improvement. To this end, in June 2008, the NAIC launched its SMI, with the purpose of conducting a critical self examination of the U.S. insurance solvency framework.

In order to get a better view of where the U.S. insurance regulatory regime stands on a global scale, the first course of action for the SMI was to examine international developments regarding insurance supervision, banking supervision, and international accounting standards and their use in the U.S. At the conclusion of the study, the SMI arrived at five key solvency areas of focus: capital requirements, international accounting, insurance valuation, and reinsurance and group regulatory issues. Issues later added to the list include corporate governance and risk management.

SMI shares some key components of Solvency II – such as the desire for an ORSA and to improve group supervision. Some of the latest actions of the group include the advancement of group capital assessment and its draft Model Holding Company Act.

At the summer meeting, regulators adopted an updated Solvency II road map, the most comprehensive issued to date, which listed progress made and benchmarks for short-

and long-term goals and reiterates the SMI’s central areas of focus: •Capitalrequirements•Governanceandriskmanagement•Groupsupervision•Statutoryaccountingandfinancialreporting•Reinsurance

More recently, regulators involved with the SMI began delving into the issues of group capital and determining what the SMI’s focus should be regarding the IAIS’s Common Framework for the Supervision of Internationally Active Insurance Groups (ComFrame) project. Industry comment around this issue seems to lean toward allowing a company’s ERM or ORSA to serve as an avenue by which group capital is reviewed rather than by a formal group capital calculation, as would be the case under Solvency II.

As industry continues to comment on the issue, the NAIC is continuing to develop out of the NAIC International Solvency Working Group an ORSA/ERM-type tool. Currently, state regulators don’t require insurers to perform ORSA assessments, stress tests, or the assessment of prospective financial positions; however, there are requirements for life insurers to opine that reserves to make adequate provisions for anticipated cash flows and economic scenarios are utilized in the process according to the NAIC.6

Recent action on the SMI also includes the advancement of the NAIC’s Holding Company and Supervisory College Best Practices paper. The practices outlined in this document encompass a range of issues, including communications between regulators; ownership and control as it relates to both coordination of form review and mergers and acquisitions; standards of management of an insurer within a holding company; and affiliated management and service agreements.

Also in the works is the SMI’s Proposal for Substantially Similar Provisions of Revised Insurance Holding Company System Model Act and Regulation. The proposal lays out the provisions states must include in any insurance holding company law or regulation it may develop. Industry comment on this model has been centered on confidentiality and the safekeeping of the types of holding company information that would be filed to regulators as outlined in the law/regulation.

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6 “Consultation Paper on the Own Risk and Solvency Assessment (ORSA) for the Solvency Modernization Initiative,” National Association of Insurance Commissioners, August 6, 2010. Retrieved from: http://www.naic.org/documents/committees_ex_isftf_iswg_orsa_consultation_paper.pdf

The IAIS, on the road to convergence

Development of the NAIC’s SMI also includes keeping a close eye on the actions of the IAIS, at which U.S. regulators are active on a number of committees. Just as the SMI is the key point of solvency modernization and improvement going forward at the NAIC, so, too, is the ComFrame initiative front and center at the IAIS. It is important to note that the IAIS is an emerging global standard setter for the harmonization of insurance regulation across the world’s jurisdictions. At present, the organization boasts membership of 190 jurisdictions in 140 countries around the world. In addition to the NAIC, it works closely with the Joint Forum, the Financial Stability Board, and the group of 20 world economy leaders, among many others. As with Solvency II, it has worked closely with the European Commission in the development of the Directive. Here, the IAIS is in line to become a major player, as the solvency standards it is developing via the ComFrame project is well- aligned with Solvency II.

Said Mr. van Hulle during his presentation at the IAIS meeting in Dubai: “The development of international standards is the best way to promote the creation of open international insurance markets, whilst at the same time ensuring that policy holders are adequately protected… If the work on Solvency II and the work of the IAIS remain well-aligned, then the relevance of IAIS standards and guidance when making equivalence determinations may increase.”

The ComFrame project is aimed at creating and implementing risk identification safeguards that would enable supervisors to keep closer tabs on insurance groups and the lingering aspects surrounding the business, for example, intra-group transaction. The initiative also seeks to produce quantitative and qualitative requirements to provide a platform for supervisory cooperation and interaction to help facilitate broad implementation. ComFrame will be developed over a three-year time frame to conclude mid-2013 and will be followed by calibration tests.

At the Dubai meeting, the IAIS adopted a two-year road map, which sets out high-level goals and strategies to confirm it is on the right track in terms of priorities and that it has adequate resources to tackle the workload.

Included in the road map were going-forward steps for the ComFrame project. As the road map shows, 2011 is expected to be a busy year. Consider the following sampling of actions steps that are planned:• AnalysisanddevelopmentofComFrameconceptpaper• Actionontransparencyissuesastheydealwiththe

relationship of IAIS jurisdictions and ComFrame and an “opt-in mechanism”

• Analysisanddevelopmentofpeerreviewandapeerassistance mechanism

• AnalysisanddevelopmentoftheComFramedatacompilation platform for macroprudential surveillance purposes

• ReviewofvariousFinancialStandardBoardrecommendations

• Developmentofsolvencyexchangesystems,withparticular focus on IAIS member jurisdictions, the NAIC’s SMI, and Solvency II

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If the work on Solvency II and the work of the IAIS remain well-aligned, then the relevance of IAIS standards and guidance when making equivalence determinations may increase.


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Moving forward—No matter where an insurance company stands in the U.S. or globally, it seems abundantly clear that Solvency II will demand a tremendous amount of work and result in a significant culture change across stakeholders of insurance and reinsurance companies – from the back office all the way up to management’s approach to making decisions.

The hope is that the new Solvency II requirements will amount to greater confidence in the insurance industry’s business model and management, as viewed not only by regulators but by rating agencies, analysts, investors, and others.

Also on the positive side, Solvency II brings with it a number of expected benefits. From the promotion of a principle-based approach in determining capital requirements, to a better alignment of risk management, Solvency II aims to put a better handle on capital analysis through the complex modeling techniques it requires. While getting there may be somewhat burdensome, companies may also come to favor the new, more comprehensive and integrated risk management that Solvency II brings, as well as the increased consistency and comparability in measurement that will be possible in jurisdictions that have achieved equivalence.

However, key challenges remain. One topping the list is the competitive advantages and disadvantages that are likely to be seen among U.S. domiciled insurers and subsidiaries of multinational companies that do business in the U.S., where the former is following U.S. capital requirements, while the latter is complying with Solvency II – resulting in a lack of consistency and the introduction of competitive advantage in jurisdictions where equivalence is not achieved.

It helps that the European Commission has recently granted acceptance under its newly created provisional equivalence regime for which the U.S. is being named. However, having been given this status, the onus is now on the U.S. to follow through and, as the European Commission suggests, “commit to converging towards a solvency regime capable of meeting the equivalence assessment criteria by the end of the transitional period.” The jury is out on whether there is consensus among U.S. insurance companies relating to the feasibility of convergence and its desired outcome.

No question, responding adequately to these new requirements will mandate a major shift in thinking for many organizations, and a rigorous and planned approach to bridge the gap between current standards and those that will be required come 2013. In light of all these factors, U.S. companies will be well-served to understand the Solvency II requirements, their implications on the risk management framework and culture, particular challenges related to U.S. products, and the plans of U.S. regulatory bodies with respect to gaining equivalence and/or adopting Solvency II-like standards.

Contacts

Howard MillsDirector & Chief AdvisorInsurance Industry GroupDeloitte LLP+1 212 436 [email protected]

Patricia MatsonPrincipalDeloitte Consulting LLP+1 860 725 [email protected]

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January 2011

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