Solvency II: More of What You Need to Know Right Now (Part II)

My first post addressed the time, expense, and extensive planning required to implement Solvency II on schedule. Today, we'll look at three more things you should know about Solvency II right now.

Accountability rolls up to the C-suite

The self-regulatory component of Solvency II, ORSA (Own Risk and Solvency Assessment), is an internal assessment process embedded in the strategic decisions of the undertaking. It is also a supervisory tool, as regulatory authorities are informed of the results.

Insurers will be required to repeat their ORSA assessment annually, so they will need processes and systems for identifying and quantifying risk that can be quickly and easily updated. They'll also need to prove that ORSA results are considered by key corporate decision-makers and that they impact the overall strategic direction of the business.

Insurers planning a partial or full alternative to the supervisor's standard model must provide a "use test" that demonstrates that the internal model is widely used and plays an important part in compliance. This will reassure regulators that management is actually using these models in its business decisions.

It is unclear whether insurance C-suite executives will be held personally accountable for their Solvency II compliance and the processes around it. While the person in charge of the financial statements and the company itself will be held responsible for shortfalls or non-compliance, there is no directive as yet regarding penalties.

What is perhaps more troubling is that many senior executives may not have a clear understanding of Solvency II in general or their own accountability. According to the 2010 SunGard study, only slightly more than a quarter of senior executives were well informed about Solvency II.

Non-compliance triggers serious consequences

If an insurance company does not meet a designated milestone or fails to implement adequate risk management processes, non-compliance could endanger its right to trade.

Regulators will also look closely at a company's Minimum Capital Requirement (MCR) and Solvency Capital Requirement (SCR) to determine if there is adequate capital on hand to cover the company's risk. If an insurer's available resources fall below the SCR, supervisors are required to act with the goal of bringing the insurer's finances back to its SCR level. Continued inability to meet the SCR will trigger intensified supervisory intervention.

Ultimately, supervisors will have the authority to impose serious penalties on insurers that fail to comply. If deficiencies in governance are identified, supervisors may impose additional capital requirements to the SCR. The aim of this "supervisory ladder" of intervention is to identify and stop ailing insurers before they become a serious threat to policyholders' interests.

If, despite supervisory intervention, available resources of the insurer fall below the MCR, "ultimate supervisory action" will be initiated: The insurer's liabilities will be transferred to another insurer, and the insurer's license will be withdrawn or the insurer will be closed to new business and its in-force business will be liquidated.

Insurers can reap big benefits from Solvency II

Despite the cost and the effort required, Solvency II compliance promises solid business benefits.

— Greater transparency into capital holdings and risk exposure offers insurers better sightlines into their operations for both investors and customers. — Better capital management will yield better data and analytics and, in turn, more informed decisions. — It's an opportunity to create business advantage. Better visibility of enterprise-wide capital preparedness may identify business opportunities and, certainly optimized governance and reporting will lead to a more efficient organization. — Solvency II is an incentive for (re)insurers to adopt a risk-based management approach. Senior executives, risk, actuarial and IT departments should work together to develop the reporting practices, management reports and dashboards necessary to create a risk-aware corporate environment. — As insurers implement processes and systems that improve their ability to track and report their exposure to risk, they will be in a much stronger position to plan business development and to manage their liquidity and risk appetite to optimize their return on capital reserves.

Solvency II promises to bring greater transparency to insurance company operations along with more and better information for improved operations and competitive advantage. By addressing the wider ERM issues raised by Solvency II, companies can minimize operational risk, potentially minimize the IT cost base, implement enhanced processes that create a more flexible organization and so potentially lower their capital requirements. For those companies that adopt this broader perspective on Solvency II, there is an opportunity to clearly stand out from the competition.

About the Author: Petra Wildemann, Global Director of Actuarial and Solvency II Consulting Services for iWorks Prophet, has extensive international experience in the insurance industry and has delivered large-scale global business and transformation programs with Accenture, FJA and IBM and insurance customers worldwide. Prior to joining SunGard, she worked for six years at Hewlett Packard as the Worldwide Director for the Insurance business.