Best Report Looks at Solvency II Directive

The current turmoil in the financial markets underscores the importance of a risk-based solvency regime and presents a real stress-test scenario for the Solvency II Directive, the proposed new European solvency standard, according to A.M. Best Co.

Although the latest Quantitative Impact Study (QIS 4) indicated that the vast majority of insurers met the Minimum Capital Requirement (MCR), and only about one-tenth of the participants did not reach the Solvency Capital Requirement (SCR), the results are based on 2007-year balance sheet data and therefore do not reflect the impact of recent events.

The current financial market turmoil has highlighted a number of key issues: the group support and supervision provision, international convergence of solvency standards, valuation and “mark-to-market” practices, which remain subject to ongoing discussion and debate by politicians, regulators and industry executives.

The European Commission (EC) is reviewing various provisions of the directive, and it is now evident that the protracted negotiations may lead to further delays in the planned implementation date of 2012. The controversial group support concept, a crucial element of the new regime, most recently has been eliminated from the framework. The new text of the draft Solvency II Directive, approved by the Economic and Financial Affairs Council (ECOFIN) on 2 Dec. 2008, means that no cross-border diversification effects can be recognized (with a significant negative impact on the groups), and each “solo” entity will have to cover its own SCR.

The debate on the directive, however, is not over, given that the European Union (EU) Commission and Parliament also have to agree on this amendment.

Whilst A.M. Best takes a global, unified approach to reviewing an insurance group’s subsidiaries in its rating analysis, the considerable differences among solvency standards around the world pose difficulties in any attempt to harmonize regulatory practises and introduce a global, consistent and efficient regulatory solvency standard.

In A.M Best’s opinion, the current financial crisis reinforces the need for enhanced enterprise risk management (ERM). Therefore, in A.M. Best’s view, progress in this area should not be delayed until the implementation of the new Solvency II regime. A.M. Best also will continue to monitor how effectively insurers utilize capital management tools in the context of the current and developing economic environment.

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