The financial crisis of 2008 led to a whole raft of new legislation designed to restrict the chances of a repeat performance, at both a local and international level. For European insurers, this means becoming Solvency II compliant. The Solvency II Directive is an EU-wide piece of legislation which harmonises regulation, primarily on how much capital insurers are required to hold. The directive will come into effect on 1 January 2014 (it was initially scheduled to start this year but authorities put it back to give firms more time to comply) and has been described by Jim Webber, former group risk officer for insurance group AVIVA, as "the biggest change in prudential regulation in my lifetime, maybe ever". And the coming of Solvency II has had a huge impact on professional services firms too, because insurers need all the help and advice they can get as they scramble to get ready for the deadline.
The overarching aim of Solvency II is to make the insurance industry less risky. It has been compared to the Basel III framework, which is set to have a similar impact on banking. Solvency II will reduce the risk that insurers can't meet claims, lessen the losses suffered by policyholders if this happens and give fair warning if such an failure looks likely. Insurers will now be required to hold capital against market risk, credit risk and operational risk, none of which are currently compulsory.
Until now, insurance companies have been regulated locally, with some countries imposing more stringent measures than others. From 2014 though, any company that meets Solvency II will be allowed to trade in the insurance markets of any EU country. It's hoped that creating a level playing field for capital requirements and prudential planning will create a safer and more competitive environment for customers.
All systems go
But insurers will have their work cut out to become compliant, and will need to revamp much of their technology. The directive requires firms to be able to value assets and liabilities homogeneously across Europe. Smaller firms will be able to implement a system for treating risks consistently across the EU relatively easily. For larger firms though, the change will need to be more comprehensive. Since the policies they deal in are more intricate and often cross-border, their systems will need to handle huge volumes of complex data, which need to be managed expertly.
Any firm hoping to become compliant will have to prove the robustness of the model they intend to adopt to regulators. It must demonstrate how it will align the model with its business and existing systems, convincing the regulator that it makes its business less risky. Rather than the top-down regulation of yore, Solvency II forces a firm to address risk management in the context of its own business.
While the outlay and upheaval have and will continue to be enormous, insurers as well as consumers will feel the benefit of Solvency II in the long run. By revamping their systems, insurers will inevitably become more efficient and less risky - the chances of large scale losses are minimalised. In conducting widespread reviews of their business, insurers may locate problems with their processes they never knew existed, again offering them the chance to become more efficient.
Professional services firms have found themselves to be invaluable advisers on Solvency II implementation. The majority of insurers have turned to the likes of the Big Four to help them become Solvency II compliant because of their knowledge of the insurance business, substantial technological knowhow and experience of restructuring business processes. If you join one such organisation in the next year or two, the chances are you'll be hearing a lot more about this far-reaching legislation.