UK: Strategic Implications: Consequences And Opportunities Arising From Solvency II

Last Updated: 19 July 2007
Article by Tamsin Abbey and Stephen Lucas

Most Read Contributor in UK, August 2017

Introduction

Solvency II is the forthcoming risk based capital adequacy directive for European insurers. It is based on a ‘three pillar’ solvency supervisory regime akin to Basel II and seeks to introduce new rigour and risk sensitivity to the quantification of regulatory capital as well as incentivise enhanced risk management and market discipline.

But who will Solvency II impact and what are the strategic implications of the European wide directive?

The ramifications of Solvency II are widespread and we can perhaps best outline the future changes to the industry by considering the strategic implication to the range of market participants from insurers, and customers, to rating agencies, regulators and the investment banks.

This paper seeks to bring to the discussion forum our hypotheses for these market participants, to identify some of the key implications and to flag where opportunities may potentially exist as a result of Solvency II. It is an eye on what might result from Solvency II in the not too distant future.

Insurers

Hypothesis – Solvency II will be a significant regulatory hurdle for smaller niche players with much of the benefits of diversification being missed by monoline businesses. 2009 and 2010 will see consolidation across the European insurance landscape leading to fewer firms but offering a more diversified product range for the customer.

Solvency II will introduce regulatory risk based capital adequacy requirements for insurers across Europe.

This will be a significant step change for many jurisdictions and the cost of compliance for insurers is likely to be significant. Adopting a risk based framework for insurers will also require a significant change in mindset. Even for jurisdictions which have accelerated the introduction of risk based capital for insurers, such as the UK with the ICAS regime, there is likely to be change required to address Solvency II, particularly around Pillar 2 and 3 requirements.

On the flip side of the effort to implement Solvency II is the value derived. One group of ‘winners’ from a capital perspective is likely to be those insurers with a diversified portfolio. Other ‘winners’ will also be the bancassurers who have already broadened risk based approaches developed for Basel II to their insurance operations. Here some of the implementation investment will have already been made and again where a diversified portfolio is offered capital benefit can be derived. For bancassurers there may be further diversification benefit gained at the group level by having both an insurance risk and credit risk portfolio. ‘Winners’ in general will be those that seek to implement Solvency II in a proactive manner, seeking to take advantage where possible and adding it to their other market differentiating factors.

Niche players and monoline businesses, however, will not benefit from capital diversification leading to imbalances in capital supporting similar products across the industry. There will still be a role for monoline and niche businesses, as has been proven by the monoline annuity businesses in the UK, but other factors become prevalent in driving business success rather than capital efficiency.

These dynamics, as well as other factors, will drive the demand for consolidation of insurers across Europe. Activity will centre around 2009, 2010 and the initial years subsequent to the new regime as firms seek to prepare and capitalise as best they can. However, there has already been some evidence of consolidation in the UK in the capital intensive with profits market, which is partly driven by better understanding by senior managers of risk and reward under risk based capital adequacy regulations.

Customers

Hypothesis – Solvency II will herald a new era in risk sensitive pricing of products leading to greater customer segmentation and more customer valued products.

Solvency II is a risk sensitive approach to determining capital adequacy and insurers’ internal models will rely heavily on data and as the granularity of this data improves across the product portfolios, insurers are more likely to be in a position to reflect capital consumption in product pricing.

This will not necessarily mean that premiums will fall, indeed implementation costs of Solvency II are expected to be high and these costs may in the short term be passed on to consumers and the pricing impact of the new capital requirement on any given product could be nil, increase or decrease depending on whether capital was appropriately allocated to these products in the past.

But over time customers will increasingly ‘get what they pay for’ and the concept of a ‘valued product’ i.e. a product in which customers see real benefit in purchasing and the risk-reward trade-off is more clearly understood than today, may emerge. Those insurers who can best price their products based on capital consumption will be strategically advantaged in a competitive marketplace. A word of caution however: this evolution will take some time and some companies may still go for increased growth/ market share even if the capital implications are unpleasant.

Rating agencies and industry analysts

Hypothesis – Solvency II will continue rating agencies’ focus on the robustness of insurers’ risk management approaches with enhanced market disclosure through Pillar 3 becoming a competing ground for those at the leading edge of risk management.

Rating agencies such as Standard and Poor’s have developed specific frameworks to evaluate the enterprise risk management of insurers and this will now be a key feature in the rating evaluation process. Insurers’ credit ratings will become further linked to the sophistication and effectiveness of their risk management capabilities.

Solvency II will also focus on the qualitative aspects of risk management and risk governance in Pillar 2. Insurers will need to put in practice reconciling quantitative and qualitative risk management initiatives to fully comply with Solvency II regulations. Insurers’ failure to implement and communicate effective risk management approaches to the regulator will lead to additional regulatory capital charges under Pillar 2: failure to do so with rating agencies may lead to credit down grade.

Demonstrating the robustness of risk management approaches to rating agencies and regulators will become increasingly important for insurers. Other participants such as equity analysts will also focus significant interest and the transparency provided through public disclosures under Pillar 3 will become a key area for insurers to demonstrate their risk management capability to a wide audience.

In short, insurers’ risk management disclosures will become a competition ground as they seek to influence third party views of their risk management approaches. This can already be seen, with some bancassurers being early adopters and seeking competitive first mover advantage with the disclosures they are making as a result of Basel II.

Regulators

Hypothesis – Solvency II will compound issues of skilled resource shortage. Regulators will have to compete with the banks, insurers and consulting houses to gain access to the limited pool of skilled risk and regulatory resources. Regulators will be forced to adopt innovative approaches to supervise the sector robustly.

Solvency II comes hot on the heels of Basel II, implemented in the EU as a risk based capital adequacy directive for banks and investment firms. The skills demanded by the banks and now the insurers target a limited talent pool. There is truly a ‘war for talent’ in the risk and regulatory space with top rated risk and regulatory specialists commanding high salaries and bonuses at all levels of seniority.

The regulators across Europe are also fighting to access this talent pool. Their ability to supervise in a consistent manner across Europe, the increasingly complex approaches to calculating regulatory capital as well as the qualitative aspects of risk management, whilst engaging with senior bank and insurer personnel, requires strong specialist skill sets.

Regulators will increasingly need to adopt approaches to best align their specialist resource with the supervisory agenda. Risk based approaches such as the FSA’s Arrow approach will become the norm across Europe with other innovative approaches to supervision emerging.

Further, the drive for other innovative approaches as well as the need for a level playing field in European supervision of insurers may provide added stimulus towards a single pan European regulator.

Investment banks

Hypothesis – Solvency II will provide a ‘hotbed’ of opportunity for investment banks as insurers seek to consolidate operations thus driving M&A activity, and restructuring their capital to take advantage from the risk based capital regime across Europe.

We have discussed above the drivers for organisation consolidation in the European insurance industry, either to take advantage of diversification of portfolios or to cope better with the implementation effort. Such consolidation will stock the pipeline for M&A teams of investment banks as well as associated legal advisors.

The investment banking activity is unlikely to be only reactive (i.e. servicing insurers M&A demand) but will also be proactive, taking opportunities to the market place. Private equity houses are also likely to become interested.

Under Solvency II the definition of capital is aligning to different tiers of capital used in the banking sector. As insurers seek to optimise their capital funding in response to regulatory capital calculation requirements and capital resource definitions, some capital restructuring is likely. Again this will provide a healthy pipeline of work for the investment banks.

It is not just capital restructuring that will be impacted. As insurers better understand their risk appetite in both quantitative and qualitative terms there is likely to be increased activity in the risk transfer market as firms try to optimise the risk reward of their portfolio. Reinsurance is one established traditional mechanism, but investment banks will also be able to take advantage of developing risk transfer markets such as insurance securitisation as these approaches become more prevalent.

Conclusion

There are significant strategic implications and opportunities that may arise from Solvency II, some of which are highlighted above. They range from how the insurers may consolidate and tackle diversification issues to capital restructuring opportunities for investment banks. Inevitable consolidation as a result of risk based capital system will see the number of insurers falling to perhaps broadly mirroring the lower number of banks currently operating in the EU.

However, the challenges of maximising the stakeholders’ value will not cease with consolidation alone because the relentless market forces will continue to drive the industry to adopt more innovative risk based capital management system to satisfy customer and product focused service demand in an ever increasing competitive world. Implementing and operating a risk based capital system under Solvency II will be a journey for the 5000 or so EU insurers and it will be fascinating to observe and support the leading firms in the market as they capitalise on the opportunities in the forthcoming years.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.