Solvency II

Background

The EU Solvency II Directive (2009/138/ EC) is a risk based capital regime that aims to harmonise the prudential framework for insurance firms to promote transparency and comparability. It amends 14 previously existing Directives which are often referred to as ‘Solvency I’, and entered into force in January 2010, with implementation effective from January 2016.  The primary concern of policy makers was the amount of capital reserves an insurance firm should hold in order to reduce the risk of insolvency. The key objectives of policy makers were to improve consumer protection, better evaluate insurers risk profiles and governance, as well as increase the international competitiveness of EU insurers.

Overview

The Solvency II framework is similar to the Basel Committee on Banking Supervision (BCBS) framework for banks, and consists of three main ‘pillars’:

Pillar I – Financial/Quantitative Requirements outline the standard formula insurance companies across the EU must use for the calculation of their capital reserves (SCR), covering all types of risk. Alternatively, with approval from the regulator, European Insurance and Occupational Pensions Authority (EIOPA) firms may use an internal model for calculation. Creates harmonised standards for the valuation of assets & liabilities.

Pillar II – Governance & Supervision sets out  the requirements for risk management, governance, and the supervisory processes for National Competent Authorities (NCAs).

Pillar III –Disclosure & Transparency Requirements describe the information and transparency reporting insurance firms must submit to supervisory authorities for public disclosure.

Scope

This Directive applies to direct life and non-life insurance undertakings, which are established in the territory of an EU Member State or wish to become established there. It also applies to reinsurance undertakings which conduct only reinsurance activities, and which are established in the territory of an EU Member State or, which wish to become established there (with the exception of the provisions of Title IV).

There are exclusions for insurance undertakings whose annual gross premium income does not exceed €5 million.

Impact on Securities Lending

Solvency II enforces direct reporting requirements and minimum capital requirements on insurance firms which provide an important source of liquidity and transact within securities lending markets. The capital requirements within Pillar I need to take into account all open loan and collateral positions, Pillar II and Pillar III require reporting by securities lending agents on behalf of insurance funds and reinsurance funds, which will need to supply quantitative reporting templates for regulatory review. It is important to note that securities lending has no impact on a firms Solvency Capital Ratio (SCR) calculation as any securities lent remain on the balance sheet of the insurer.