Solvency II: Is flexibility just protectionism under a different name?
It has been ten years in the making, has been the subject of intense debate both inside and outside the industry and is now scheduled to come into force (belatedly) in 2014. I am of course referring to the so-called Solvency II (S2) regime under which insurers will be required to adopt stricter capital reserve rules relative to the type of risks they insure - more commonly known as risk-based-capital (RBC).
The concept of RBC solvency for insurers and reinsurers is nothing new. During the past fifteen years, most major economies around the globe have moved from fixed capital standards for their solvency regulation to some form of RBC standards. Canada and the US were among the first to introduce these risk-based standards, in 1992 and 1994 respectively. Japan followed with the “solvency margin standard” in 1996 and Australia with the “general insurance reform act” in 2001.
For any risk-based system to succeed it must be comprehensive, fully integrated and above all flexible. A flexible scheme, where risk-based-capital standards are used as guidelines - to assist insurers in managing their risk structure - rather than as absolute requirements, would yield a variety of risk strategies. The right flexibility could also limit the possibility of systemic risk inherent in using a single standard model for all or even most insurers.
For S2 to work (on any level) any such flexibility needs to maintain the correlation between capital reserves with underlying risk. The news this week that the European Commission is considering a watering-down of Solvency II to allow a phased-in period for historic life insurance products brings into question the motivation behind this particular brand of 'flexibility'. Of course, persistently low interest rates make it harder for life insurers to achieve the minimum guaranteed returns to existing customers, but isn't that the point of S2 - to match capital with underlying risk?
This 'exemption' is being marketed with a warning that many smaller German life insurers could otherwise face immediate difficulties if S2 is implemented in its current form. However, given that the major benefactors (of any such delayed introduction) would be the large German multi-national insurer such as Allianz and Munich Re, we can't help wondering if political desires, not capital adequacy, is now driving the S2 agenda.
If so, flexibility (in the context of S2) will be just another word for protectionism.