Solvency II and its consequences

The first regulatory requirements for insurance companies in the European Union were introduced in the 1970s, known as Solvency I. Since then, sophisticated risk management systems have been developed.

Solvency II introduces a comprehensive framework for risk management for defining required capital levels and to implement procedures to identify, measure, and manage risk levels. It is the updated set of regulatory requirements for insurance firms that operate in the European Union.
The rationale for the European Union behind this framework is the development of a Single Market in insurance services in Europe, whilst at the same time securing an adequate level of consumer protection.

Solvency II is based on economic principles for the measurement of assets and liabilities. Risk will be measured on consistent principles and capital requirements will depend directly on this which means that it is a risk-based system, too. It is somewhat similar to the banking regulations of Basel II. It also consists of three pillars:

· Pillar 1 focuses of the quantitative requirements (e.g. the amount of capital and insurer should hold)
· Pillar 2 consists of requirements for the governance and risk management of insurers, as well as the effective supervision of insurers
· Pillar 3 concentrates on disclosure and transparency requirements

A solvency capital requirement may have the following purpose:
· Reduce the risk that an insurer would be unable to meet claims
· Reduce the losses suffered by policyholders in the event that a firm is unable to meet all claims fully
· Provide early warnings for supervisory so that they can react promptly if capital falls below the required level
· Improve the confidence level in the financial stability of the insurance sector

I think Solvency II is an important step forward in the effort to improve insurance regulation, to foster risk assessments and to rationalize the management of large firms. The directive, especially if complemented by indicators that take the lessons from the crisis into account, would remedy the present fragmentation of rules in the EU and allow for a more comprehensive, qualitative and economic assessment of the risks.

The directive has been agreed by the EU and will be implemented starting year 2012. For the insurance industry this will mean a paradigm shift of their business related decision processes. The goal is not to create more regulations. It must be in the interest of the industry itself to find solutions, risk models, and other concepts that prepare them for upcoming crisis. Solvency II is just a vehicle to articulate those needs and guide the insurers in the right direction.

Right now, the insurance industry reached the point where they understand the necessity of an intelligent risk management. It is recognized as a value generating process as well as a competitive advantage. However, the implementation of Solvency II is still in the early stages of development.

It is easier for large insurance organizations to budget for the development of company-specific risk models. For small insurers this is a real obstacle, which leads them to the conclusion that they have to build their models still Excel-based.

Besides, the main hurdles for the implementation of Solvency II seem to be data availability and quality. Insurance companies are known for their heterogeneous IT system architecture. Data consistency, data integrity, flexibility and good performance of reporting and analysis are not easy to achieve. In fact, the contrary is true!

So what are the consequences?

Even though the insurers have still some time before the implementation of Solvency II is mandatory, they definitely need to start working on a solution that fits their needs for their own sake.

Insurance companies do not have all the answers themselves. They need to reach out to experts who know how to extract their data, identify the right KPIs, build an integrated, qualitative good and consistent data layer, and a flexible, well performing reporting solution that meet their needs and the requirements of Solvency II.

An integrated BI system that enables the business to analyze their data quickly down to the deepest level while at the same time building the confidence in the accuracy of the data is priceless. The feedback that I am receiving from my clients is that easily understandable state-of-the-art reporting capabilities (like dynamic dashboards) that allow the user-specific visualization of information from different angles without making the mistake of being to excessive help significantly with the adoption of the new regulations.