Solvency II and Asterix the Gaul

Solvency II and Asterix the Gaul
Since the publication of my Solvency II report in April 2008, there have been a lot of discussions around the new set of prudential regulation currently in implementation in Europe. For instance there is a wave of criticism coming from France notably from major players on the market. According to Groupama, a few internationally diversified banks have nearly collapsed in the recent past, demonstrating that the Basel II regulation could not prevent even well-diversified institutions from experiencing solvency problems. Therefore, what happened to the banking sector with Basel II during the financial crisis should prompt a reconsideration of the whole set of regulation and approach of Solvency II. More recently a French association gathering mutual insurers called the “Réunion des organismes d’assurance mutuelle (Roam)” representing 7% of the French market (around 10 million insured) has launched a website called “stopsolvabilite2.com” demonstrating that not only major French insurance players are worried about Solvency II and dubitative about the real benefits the new set of regulation can bring. Among others, what French insurers and mutual companies fear is that Solvency II could have potential negative consequences on future growth and consumers. They believe that consumers would not be more protected than they are today with the current solvency regulation, and in addition they think that Solvency II might trigger tariff increases and decrease the level of competition due to concentration or failure of companies. These actions led by French insurance companies could trigger new rounds of discussions and delay the effective implementation of the Solvency II directive. There is a country in the middle of the European Community, whose some insurance companies have decided to resist. This could be a new story of Asterix the Gaul.

1.14.10: Celent Insurance Webinar: What’s Next for Insurance Solvency Regulation and Technology in the US?

1.14.10: Celent Insurance Webinar: What’s Next for Insurance Solvency Regulation and Technology in the US?
Celent senior analyst Donald Light This event is free to Celent clients and the media. Non-clients can attend for a fee of USD $249. Celent will contact non-clients after they register for credit card information. Please click here for more information.

Federal Regulatory Reform of Insurance – The First Salvo

Federal Regulatory Reform of Insurance – The First Salvo

The Obama administration published its white paper on financial services industry reform this week, Financial Regulatory Reform: A New Foundation, Rebuilding Financial Supervision and Regulation (http://www.financialstability.gov/docs/regs/FinalReport_web.pdf) . This will now serve as a baseline against which the legislative process can act. So, while this is not law yet, there are some broad trends which can be noted in the approach which will have implications for insurance firms and their technology response.

A high level review of the document reveals the broad goals for insurance industry regulation and the proposal of two regulatory agencies which will directly affect the way business is done. Taken from the report, the principles underlying the recommendations specific to insurance are:

  1. Effective systemic risk regulation with respect to insurance
  2. Strong capital standards and an appropriate match between capital allocation and liabilities for all insurance companies
  3. Meaningful and consistent consumer protection for insurance products and practices
  4. Increased national uniformity through either a federal charter or effective action by the states
  5. Improve and broaden the regulation of insurance companies and affiliates on a consolidated basis, including those affiliates outside of the traditional insurance business
  6. International coordination

I anticipate much angst around points four and five, especially as these directly challenge the state regulatory set up and its effectiveness and efficiency. On a broad level, no one can argue that these are worthy goals, but how they are accomplished will be contentious.

The establishment of two regulatory agencies is proposed — the Office of National Insurance (ONI) and the Consumer Financial Protection Agency (CFPA). The duties of the ONI are fairly well detailed. From the report: “The ONI should be responsible for monitoring all aspects of the insurance industry. It should gather information and be responsible for identifying the emergence of any problems or gaps in regulation that could contribute to a future crisis. The ONI should also recommend to the Federal Reserve any insurance companies that the Office believes should be supervised as Tier 1 FHCs. The ONI should also carry out the government’s existing responsibilities under the Terrorism Risk Insurance Act.” The ONI will also serve as the U.S. representative to the International Association of Insurance Supervisors with “the authority to enter into international agreements, and increase international cooperation on insurance regulation.”

The potential impact on insurance of the CFPA is less clear. The report states that it would “protect consumers across the financial sector from unfair, deceptive, and abusive practices in credit, savings, payment, and other consumer financial products and services”. Insurance products, particularly life instruments such as variable annuities, are not specifically mentioned. The emphasis is on preventing a repeat of the perceived improprieties seen in the mortgage and credit card areas. However, it does not specifically exclude insurance and “other consumer financial products and services” is a very broad area.

Some of these lines will be drawn during as the Congress develops its legislation. Many, especially where Federal responsibility ends and state requirements begin, will only be determined once the Federal system is in place and active. The practical impact to insurance industry is that there is another sheriff in town now and they will be demanding our time and attention. Companies must prepare now for stress on their data management and compliance processes. (See the Celent reports Insurance Data Mastery Strategies http://reports.celent.com/PressReleases/20081126/DataMasteryStrategy.asp and Insurance Data Mastery Solution Spectrum http://reports.celent.com/PressReleases/20081203/DataMasteryVendors.asp). Pending upgrades to data management tools should happen now and any planned data conversions completed. Companies without a robust reporting environment should invest in these capabilities as the up front investment will be less than the continued expenses associated with a “catch up” approach. In 2010, plan for short timelines for compliance and a more confusing and expensive regulatory landscape.

As expected, Solvency II is under threat

As expected, Solvency II is under threat

In April 2008, Celent published a report about the new regulatory approach for insurers and reinsurers operating in the European Union called Solvency II.

Surprisingly or not, the draft text submitted to and approved in the beginning of December by the European Council of Economic and Finance Ministers (ECOFIN) does not contain the group supervision provision any longer. With Solvency II, capital requirement is based on a risk-based system as risk is measured on consistent principles. Knowing that, the removal of the group supervision requirement is an important change to the overall Solvency II regulation. Indeed, the idea behind Solvency II is to encourage large and diversified groups because they can pool their capital resources which should in turn benefits to policyholders. This approach is directly derived from the Basel II regulation implemented for the bank industry.

In other words, it seems that some factors have played an important role during the last six-month period and led the policy makers to reconsider the pros and cons of the group supervision provision. First of all, a few internationally diversified banks have nearly collapsed in the recent past demonstrating that the Basel II regulation could not prevent even well-diversified institutions from experiencing solvency problems. In the insurance sector, the American International Group (AIG) has been seriously hit due to its vast financial exposures that were written at the group level. In addition, after the massive interventions of governments to save some of the biggest European financial institutions, political pressures have emerged. France, for instance, seems to be in favor of the deletion of the group support element of the directive. This decision is also due to the fact that mutuals – which are preponderant in France – tend to have lower solvency ratios and capital requirements. Smaller countries in Eastern Europe are also concerned since they fear losing control over some of the entities. According to a report published by FSA in April 2008 (Enhancing group supervision under Solvency II), foreign insurance subsidiaries own 98.6% of market share in the Slovakian life sector and 100% in the non-life. These figures help us better understand the small Eastern European countries concern.

Overall, the immediate consequence of the ECOFIN decision could trigger new rounds of political discussions and delay the effective implementation of the Solvency II directive. In this context, Celent thinks that 2012 might be a too optimistic objective. However, we still encourage insurers to prepare for the Solvency II implementation because the new set of capital requirement regulation means changes and will trigger new investments anyway.