A review of Solvency II: Has it met its objectives?

Abstract

Solvency II is currently one of the most sophisticated insurance regulatory regimes in the world. It is built around the principles of market consistency and embedding strong risk management and governance within insurance companies. For business with long-term guarantees, the original basis produced outcomes that were unacceptable to the member states. The original design was amended through Omnibus II. The working party has looked back at the outcome of the final regulation and comments on how well Solvency II has fared, principally from a UK perspective, relative to its initial goals of improved consumer protection, harmonisation, effective risk management and financial stability. We review Pillar 1's market consistent valuation (including the risk margin and transitional measures) as well as the capital requirements (including internal models). We look at the impact this has on asset and liability management, pro-cyclicality and product design. We look at Pillars 2 and 3 in respect of the Own Risk and Solvency Assessment, liquidity and disclosure. Finally, we stand back and look at harmonisation and the implications of Brexit. In summary we conclude that Solvency II represents a huge improvement over Solvency I although it has not fully achieved the goals it aspired to. There are acknowledged shortfalls and imperfections where adjustments to Solvency II are likely. There remain other concerns around pro-cyclicality, and the appropriateness of market consistency is still open to criticism. It is hoped that the paper and the discussion that goes with it provide an insight into where Solvency II has taken European Insurance regulation and the directions in which it could evolve. KeywordsSolvency II; Market consistency; Effective risk management; Risk margin; Brexit 1. Summary of Paper and Conclusions of the Working Party 1.1. Solvency II Solvency II has been under consideration and development since the early 2000s. The previous regime, in force since the 1970s (which had come to be known as Solvency I), was not risk-sensitive and a number of key risks, including market, credit and operational risks, were not explicitly taken into account in capital requirements. Furthermore, Solvency I permitted the continuation of different methodologies in different EU countries, e.g., either book or market value of either assets or liabilities, depending on country.

Solvency Evaluation Model of Insurance Company Based on Stochastic Differential Equation

“…d 3 μ is the part of the fund that moves out of the risk state. Condition (5) requires that the difference between this part and the part that flows in the risk state should not be less than the fluctuation range. In fact, the fund that moves out of the risk state should be able to resist the risk faced by the fund that is in the risk state; that is to say, the insurance organization should make appropriate adjustment and control according to the investment status in order to ensure the system to enter a stable state.…”

“…Cooke et al [4] also found that Solvency II reduces the impact of risk margin and reduces the technical reserve of insurance companies. Rae et al [5] believed that Solvency II has not achieved the expected goal, and there are still some areas that need to be adjusted and improved in terms of procyclicality and market consistency. Pablo Duran etal.…”

Risk premia and the European government bond market: new empirical evidence and some thoughts from the perspective of the life insurance industry

“…In addition to harmonizing the EU insurance market and improving EU insurers’ competitiveness, Solvency II mainly aims at promoting a more resilient regulation, effective risk management and transparency (see, for instance, Rae et al. 2018 and Hopt 2013 ).…”

Interest rate risk of life insurers: Evidence from accounting data

“…For instance, the United Kingdom was early in introducing capital requirements that were sensitive to duration matching (Swain & Swallow, 2015) and Solvency II has been evolutionary, rather than revolutionary. For Germany, where the regulatory regime has been based around historical cost accounting, Solvency II has been a large change (Rae et al., 2018). This suggests that, particularly in Germany, regulatory constraints varied over time.…”