Opportunity in Solvency II?

Solvency II will change the investment behavior of European insurance companies, notes a new report, but if done correctly, insurers can optimize its return.

Insurance Networking News, October 19, 2011

INN Editorial Staff

The discussion around Solvency II as an albatross to European insurers trying to improve their risk management efforts appears to becoming moot.

In its “Solvency II Revealed” report, Aon Benfield, the global reinsurance intermediary and capital advisor of Aon Corp., offers insights on the regulatory challenges of the EU protocol and includes important considerations for the personnel who will be managing under the regulation’s compliance rules, from chief financial officers and chief risk officers, to actuaries and catastrophe modelers.

The report contains a series of in-depth articles on the key challenges of the new regime based on actual client projects.

Themes highlighted in the report include:

* Combining the management of insurance and market risk, and leveraging the internal model framework, enables insurers to optimize their overall business strategy across insurance and investment risks and deliver higher shareholder returns without increasing risk or capital.

* Solvency II will change the investment behavior of insurance companies. Allocating risk and capital across underwriting and investment risk more dynamically provides an opportunity to deliver a more stable return to shareholders through the underwriting cycle.

* Insurers do not necessarily have to choose between a reinsurance program which achieves business objectives and one which reduces capital requirements. A non-proportional treaty with or without frequency protection (aggregate covers) can substantially reduce capital requirements as an additional benefit to the protection against unexpected losses.

* Internal models, despite requiring a significant investment, result in more accurate calculations of solvency capital for catastrophe risk. Irrespective of whether the standard formula or an internal model is used, catastrophe excess of loss reinsurance remains the leading mitigation tool for natural catastrophe risks and a cost effective source of capital.

* Pandemic and terrorism risks drive the life catastrophe capital requirement. Fully transparent models, such as those developed by Impact Forecasting, allow insurers to demonstrate internally, as well as to regulators, how to potentially quantify these risks.

* Ratings agencies are unlikely to change their ratings processes as a result of Solvency II but insurers that can demonstrate an effective internal modeling process may achieve favorable capital adjustments under the rating agency models over time. This could mean a reduction in the capital needed to support their rating.

* Many insurers have chosen to reap the benefits of using an internal model for Pillar 1 but these can also play a positive role under Pillar 2 as part of the Own Risk and Solvency Assessment (ORSA) to demonstrate to regulators that risk is being effectively managed.

* Calculating the fair value of a reinsurer's share of technical non-life liabilities could be a challenging task if the reinsurance program has changed in recent years. The report examines the Solvency II framework and presents two different approaches from a practical perspective.

For more information on related topics, visit the following channels:

• Compliance
• Risk Management
• Underwriting