Rising to the challenge: Supporting clients with Solvency II

Solvency II is the new proposed EU legislation which will govern the risk- and economic- based capital requirements of insurance companies operating in the European Economic Area. It also defines new enterprise-wide risk management requirements. Companies preparing to meet these new requirements can benefit from Swiss Re’s experience with economic models and economic-based solvency regimes, including the Swiss Solvency Test.

The impact

Solvency II is the right approach because it combines (i) total balance sheet and economic-based solvency assessment, (ii) strong reliance on qualitative risk management requirements, and (iii) enhanced market discipline through increased disclosure requirements and transparency. This represents a paradigm shift in insurance supervision, the outcome of which should be insurance companies with a better understanding of the risks they take and regulatory incentives that promote state-of-the-art risk management and greater transparency.

What changes?

The current framework, Solvency I, was introduced in the early seventies and defined capital requirements by specifying simple, factor-based solvency margins. While Solvency I capital margins were designed to act as a buffer to absorb potential risks and to protect policyholders, experience has shown that they do not always reflect the true risks in a given insurance portfolio. The shift to Solvency II is a significant one in several respects: Under Solvency II, an insurance company's entire risk landscape is taken into account when the calculations for solvency requirements are made. As a result, the different risk categories that drive capital requirements are more important under Solvency II than before.

Market and underwriting risks

Insurers face risks both on the underwriting side and also in terms of the assets in which they invest. Market risks, such as the risk that equity prices might fall or that bond spreads widen, will in future influence the amount of capital that companies will be required to set aside. Risks relating to the business that insurers write, such as peak risks from natural catastrophes or having an insufficiently diversified portfolio, can equally drive capital requirements under Solvency II.

Reinsurance as an efficient capital management tool

Reinsurance solutions exist in order to address these risks. For instance, peak risks from natural catastrophes can be shared by reinsurers through non-proportional reinsurance or transferred to capital markets with Insurance-Linked Securities. Furthermore, the issue of insufficient diversification of the insurers’ portfolio could be addressed by entering into a quota share agreement with a reinsurer, or the volatility of the reserves can be easily transferred via retrospective reinsurance solutions. Under Solvency II, reinsurance is recognised as a powerful tool to manage capital.

Supporting our clients

Swiss Re can support clients in evaluating the most efficient solution for their particular needs under the model they choose to determine their capital requirements by. We have many years of practical experience with economic models, and with economic-based solvency regimes such as the Swiss Solvency Test. In addition, we have the capacity and expertise required to support clients at this strategically important time.

Published 1 December 2011

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