Solvency II: ‘Beware the Dog That Didn’t Bark,’ Warns Willis Re

April 13, 2011

Insurers are meeting their solvency requirements in greater numbers than anticipated and the result is that the Solvency II regulatory scheme will not result in a capital deficit for the insurance industry as a whole.

The latest impact study (Solvency II Quantitative Impact Study, known as QIS5), conducted by the European Insurance and Occupational Pensions Authority between August and November 2010, points to the reinsurance/insurance industry being comfortably well-capitalized and in relatively good shape for the implementation of Solvency II in 2013.

The study showed a smaller than expected increase in the number of companies failing to meet their Solvency Capital Requirement, the threshold below which regulators will be required to intervene. The number of companies failing to meet their solvency requirements rose from 11 percent for 2008’s QIS4 to 15 percent for QIS5.

The reinsurer Willis Re, in a review of QIS5, looks at whether this positive result masks underlying issues. The Willis Re report is titled, “Beware the Dog that Didn’t Bark – Is the European Insurance Industry Really Ready for Solvency II?”

According to this Willis Re analysis, companies are making progress but many still find the rules complex. Also, while the European Commission has raised the possibility of a gradual implementation of Solvency II requirements over a period of up to 10 years, giving companies and regulators some breathing space, Willis Re said it believes that the relatively benign QIS5 results may remove the pressure for a gradual transition period.

While the number of companies failing to meet their solvency requirements rose from 11 percent to 15 percent, Willis Re said that the increase was not as dramatic as expected considering the impact of the financial crisis on insurers’ balance sheets, the sharp increase in standard formula risk factors used in QIS5, and the doubling of the number of small insurers taking part in the exercise. Small insurers were expected to fare comparatively badly due to their limited diversification.

On a whole, Willis Re said that the QIS5 study points to the industry being in relatively good shape for Solvency II in 2013.

However, Willis Re said that a closer analysis of these unexpectedly benign results, finds that:

  • • Many participants felt that a number of SCR sub-modules were disproportionately complex which led to widespread use of simplifications. A notable example of this was the counterparty default risk sub-module.
  • • The catastrophe risk sub-module was the most criticized. Respondents’ feedback was, to some extent, contradictory as they complained both about the complexity of data requirements and the limited sensitivity to actual risk exposure. However, the latter issue cannot be addressed without further increasing the former. Willis Re believes that a fundamental review of CAT risk treatment is needed – extending the concept of Undertaking Specific Parameters (USPs) to the catastrophe calculation.
  • • The number of insurers submitting internal model results was too small to draw general conclusions. However, the results indicate that internal models did not provide materially different outcomes from the standard formula. Quite surprisingly, a significant number of insurers that have already applied for regulatory approval did not use their models in QIS5, for example in the UK.

David Simmons, managing director, Analytics and Head of International Risk Management for Willis Re, said many companies, large as well as small, struggled with the complexity of QIS5.

“Some parts of the standard formula, in particular the catastrophe risk module, do work for many companies’ risk profiles,” Simmons said. “The answer may be internal capital models, but QIS5 shows that companies are making slow progress in this area. It is also debatable whether national regulators have the resources to deal with the increasing number of internal model approval requests.”

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