A Great wave of water is washing over the Midwest. According to the news programs I listed to as I drove across Northern Illinois this week, while the water had crested at the Fox River (visibly swollen from Interstate 90) areas downriver in the Mississippi system were due to face rising waters as the floods that have devastated Iowa drained in their direction.

It wasn’t clear from the announcements how severely these more southerly areas could be affected, but it was ominous to reflect on the building, slow-motion character of the floods. The Iowans who watched the waters build at the end of this rainy spring were better off than those who recently suffered disaster without warning in that state, and those in other areas with more warning still are in a better position to take what measures may be available to secure their lives and property.

As I gathered sources for a story on Solvency II the inexorable character of the rising waters provided a metaphor to think about the possible consequences of changing European insurance regulatory framework. As Solvency II moves forward to its 2012 effective date, American regulators and insurers have plenty to think about. The Europeans felt the need to clean house and adapt to a changing competitive field. As a result they are moving toward a state-of-the-art regulatory approach that uses sophisticated risk management and capital allocation to establish an economic or “full fair value” approach to measure companies solvency.

According to Celent’s Nicolas Michellod, author of “Solvency II: Overview and Impact on IT,” European insurance companies will invest between €700 million and €900 million on IT projects to comply with Solvency II.

If the Europeans are right about their need to overhaul their regulatory system in order to compete effectively, their arguments should apply to the United States as well, to the extent that the American insurance industry participates in the global insurance market and competes with its market leaders.
“The US is watching, interested, recognizing that the leading edge in risk and performance measurement is European based,” says Bob Stein, Director of Ernst & Young’s global financial services practice.

Companies outside the European Union are watching Solvency II not only as a regulatory development but as a managerial leap forward, in that it will institutionalize advanced risk management methodologies. “There aren’t many U.S. companies that have anything comparable,” Stein comments.
That being the case, American companies will eventually be at a disadvantage in their ability to more accurately price products and manage risk. “We’re rapidly becoming outliers in the global markets,” Stein says.

Like the gradually building floods in the Mississippi basin, the threats posed to the U.S. insurance industry by the Solvency II are visible from a long way off. The question is whether American insurers and their regulators will move with the speed necessary to stave off potentially disastrous consequences.

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