Dave Matcham

Thoughts for 2010 (1) – Market Modernisation and Solvency II Symbiosis

Two of the market’s biggest current priorities, namely Solvency II and the continuing modernisation programme will continue to attract much attention in 2010. On the face of it they are separate initiatives ie. one is regulatory, the other technology and process change, however there is a high dependency between the two. I believe that they are not mutually exclusive.

At a recent technology forum it was estimated that up to 40% of Solvency II implementation costs were related to technology. This would include modelling software, data warehousing and consideration of data quality. It was commented at the forum that if one were to prioritise finite resources to the two initiatives, Solvency II would prevail. This after all is a fundamental change in regulatory infrastructure with a specific timeline leading to implementation in November 2012. Market modernisation however is more of a continuous improvement process as technology provides opportunities for further efficiencies.

One of the key 2010 modernisation projects is the wider implementation of ACORD data standards. This will be seen in the greater use of the Lloyd’s Exchange for endorsements and other peer to peer solutions between brokers and carriers. ACORD data standards enable validated data to be submitted and reused without re-keying. Interestingly, this initiative directly complements the need for high quality data to be available for analysis of risk and capital modelling for Solvency II. One could say that there is a regulatory imperative for insurers to be ACORD standard compatible as this would at least give greater assurance that data received and processed by insurers will be of high quality and give regulators greater comfort that their capital modelling is adequate. Without improvements in data quality, a company’s internal capital modelling might need greater margins of error for them to be acceptable.

The last time a market “reform” project had direct regulatory connections was the introduction of the contract certainty code of practice. Contract certainty is now very much business as usual in the market and part of the dialogue undertaken between regulated entities and the FSA.

Solvency II obviously has greater emotion attached to it and will be directly affected by many aspects of a company’s business. I believe that many companies are also seeing the direct connection between data standards and internal capital modelling, therefore directing enough resource to become ACORD compatible could well be a good investment decision for the future.

Solvency II – Good but not perfectly formed

At last, we have political approval within the intended timescale to a new risk-based regulatory framework for insurance regulation in the EU – Solvency II. After much negotiation between the European Parliament, Commission & Council a compromise was reached which broadly speaking is positive and at least gives certainty. However, it is not, unfortunately, optimal because group support, an important element advocated by the industry, has been omitted for what look like political reasons. The key to group support is that it would have allowed large companies to achieve better capital efficiency; consequently some may now be less engaged in the process. This opportunity has now been missed as capital requirements will be set at a local level and not by a lead supervisor. Insurance and reinsurance is a cross-border industry but will not be fully regulated accordingly. There are however many wins in this agreement not least a new framework which underpins the industry for years to come and which may, at least in substantial part, become a global standard. Many believe that the agreement on Solvency II has come at an ideal time and demonstrates a belief that economic, risk-based, transparent approaches are right for the current climate. Regulated firms will have much to do now to ensure they are ready for Solvency II D-Day, sometime in 2012 (or perhaps 2013).

Looking Ahead - Solvency II in 2009

2008 was an important year for the development of the new risk based regulatory framework within the EU otherwise known as Solvency II. Given the recent lack of consensus within EU institutions, 2009 seems like being vital for the future of Solvency II.

Much has been written in the press following the vote by the Council of Ministers to implement a Solvency II framework without group supervision. This decision, partly politically motivated, is a major setback for the overall framework. The insurance industry has expressed its disappointment, commenting that without this essential plank the whole Directive is significantly diluted. The insurance industry is global and its regulatory framework needs to reflect this fact.

The EU Parliament and in particular the Directive’s rapporteur, Peter Skinner, are disappointed at the Council’s decision and are now trying to smooth out the frictions which exist over the group supervision concept. This Directive has been worked on for the last five years and whilst without group supervision there would certainly be some meaningful reform, a huge question mark hangs over a framework without group supervision, not least from the worldwide supervisory perspective.

A key time for 2009 will be when the full framework goes before a plenary session of the European Parliament. This takes place in February 2009 and will be the first opportunity for Parliamentarians to vote on the final version.

We believe that it is essential that group supervision is part of this final version and will do all we can in the weeks leading up to this vote to persuade opinion-formers to retain the concept.