Basic Overview

Solvency II is a European Union legislative initiative for regulating insurance businesses by setting out capital and corporate governance requirements. This is similar to the approach taken to regulate banks and investment firms under the Capital Requirements Directive.

Solvency II takes effect in October 2012 and will bring about a significant change in the way risk is viewed. Firms must define their own risk profile and show that they have sufficient capital to meet this level. Firms must also demonstrate that they have sufficient risk management and corporate governance mechanisms in place.

Solvency II introduces a number of new capital requirements – the Minimum Capital Requirement and the Solvency Capital Requirement.

There is a requirement that firms establish a risk management function, a compliance function and an internal audit function as well as the actuarial function. This aligns practice in insurance companies with the model established for investment firms under MiFID (the Markets in Financial Instruments Directive).

Lastly, for groups with cross-border operations, Solvency II will strengthen the role of the group supervisor who will have specific responsibilities to be exercised in close cooperation with individual national supervisors. This will mean that the same economic risk-based approach will be applied to insurance groups which can now be better managed as a single economic entity. Furthermore, the new solvency provisions will foster and force greater cooperation between insurance supervisors and will further supervisory convergence.

These various issues are dealt with under the three ‘Pillars’ to the structure of Solvency II:

Pillar 1 – Quantitative Pillar – deals with capital requirements such as the Minimum Capital Requirement’ (“MCR”) and the Solvency Capital Requirement (“SCR”).
Pillar 2 – Qualitative Pillar – deals with governance requirements, the Own Risk & Solvency Assessment (“ORSA”) and the Supervisory Review Process.
Pillar 3 – Disclosure Pillar – deals with disclosure requirements such as the annual published financial solvency & financial condition report.