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Deloitte
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The publication of the draft framework for Solvency II, the new capital adequacy directive for European insurers, is a major step towards establishing a level playing field across Europe, according to the business advisory firm Deloitte. However, Rick Lester, insurance partner at Deloitte cautions that the new framework generates a number of challenges for insurers trying to adhere to the rules:

“Solvency II will be a significant step-change for many jurisdictions and the cost of compliance for insurers is likely to be high with the costs in the UK running into hundreds of millions of pounds.  Even for jurisdictions which have accelerated the introduction of risk-based capital for insurers, such as the UK with the Individual Capital Adequacy Standards (ICAS) regime, there is still further work required to address Solvency II.”

“The announced delay to the implementation date of the Directive to 2012   should catch few stakeholders by surprise given the sheer scale of the task being undertaken and participation of nations with a very diverse view of insurance capital adequacy supervision. The framework sets the high level principles, but there will be significant work and negotiation required to arrive at implementation guidance which meets the needs and expectations of the 27 member states.”

Winners and losers
Deloitte notes that there will be winners and losers from the new regime:

“One group of ‘winners’ from a capital perspective will be those insurers with a diversified portfolio. Monoline businesses will not benefit from capital diversification and this may lead to imbalances in capital supporting similar products across the industry. Such insurers may compensate the lack of diversification benefit in their capital requirements by offering more innovative customer tailored products.”

“Like monoline insurers, customers may find they are also losers following the introduction of Solvency II.  In the short-term the implementation costs of Solvency II may be passed on to customers. However, over time, customers will find they pay even more for the risk being insured. Those with low risk profiles will pay less but those in high-risk areas, such as earthquake or flood zones may find their property becomes uninsurable, or the insurance unaffordable.”

Consolidation
Deloitte predicts there will be an inevitable acceleration of consolidation as a result of the introduction of new more risk sensitive capital standards.  

“Solvency II will be a significant regulatory hurdle for smaller players with much of the benefits of diversification being missed by monoline businesses. These dynamics will drive the demand for consolidation of insurers across Europe as diversified groups will have a pricing advantage. We are also likely to see consolidation in product areas which are capital intensive under a risk based approach”

Interaction between IFRS and Solvency II
Alex Arterton, the partner leading Deloitte’s insurance centre of excellence, commented: “The delay in implementing Solvency II may give insurers a better chance of aligning regulatory and financial reporting as Phase II of the IFRS insurance contracts standard is developed over the next two years.   On the other hand if IFRS Phase II gets delayed then insurers seeking to develop integrated financial and regulatory reporting systems that rationalise accounting and actuarial processes will face increased uncertainty as to whether their current plans will deliver an integrated solution to all their reporting needs when the frameworks are finally delivered.”

International Arena
The publication of draft framework Directive for Solvency II will also be closely monitored by non EU countries and there are expectations that US and Asian regulators will move towards a Solvency II type regime over time.

“The prospect of global solvency standards based on the EU standard should provide an early mover advantage to EU insurers in the same way that UK insurers are well positioned for the Solvency II as a result of the existing ICAS regime,” added Lester.

Ends

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