Dream a little dream

The European Commission's Solvency II Directive is being drafted to create a consistent regime throughout Europe. David Worsfold warns UK insurers, however, that divisions on its direction remain stark

Battle lines are being drawn up in Europe, as the European Commission beavers away drafting the much-talked about Solvency II Directive.

This will - at least in theory - attempt to create a single, consistent capital and solvency regime throughout Europe. Initial signals from the EC and the key Committee for European Insurance and Occupational Pensions Supervisors, to which the UK's Financial Services Authority belongs, appeared hopeful to those pursuing this particular harmonisation Holy Grail.

The modern approach, which forms the core of the FSA's own capital adequacy regime, of a risk-based, market-consistent regime, looked set to lie at the heart of the new Solvency II regime.

A series of conferences and smoke signals from the EC during the autumn have, however, dashed hopes that this is a battle already won.

Solvency doubt

At a CEIOPS conference in Frankfurt during November, some national regulators, who are wedded to a more traditional prudential approach to regulation, made it clear that Solvency II was far from a done deal. Led by the French, they cast doubt on the market-based approach and demanded that prudential risk reserves be given a role in the new regime.

"I like to hear the word 'prudence'. I don't think a market in insurance liabilities exists," said Florence Lustman, secretary general of the French regulator, Commission de Controle des Assurances, des Mutuelles et des Institutions de Prevoyance.

Karel van Hulle, head of the EC's insurance and pensions unit, which will play a central role in drafting the directive, then appeared to give a nod in the direction of those resisting a pure, market-based approach to solvency. When answering questions at the CEIOPS conference, he said: "Some people dream about markets every second; others are more realistic."

This hint at a compromise has set alarms bells ringing across Europe, best summed up by Gerard de la Martiniere, president of the Comite Europeen des Assurances, the European trade body for insurance companies: "Supervision will have to change. We don't want old-style prudence rules and floors within a risk-based approach."

The issues behind this are extraordinarily complex but, in essence, the real fear among UK practitioners is twofold. Firstly, they worry that the FSA will press on with rolling out its own risk-based solvency regime, regardless of how the debate on Solvency II develops and that, in three or four years' time, the regulator will then have to undo much of what it has done.

Secondly, there is a fear that the EC is being too idealistic in its objectives, wanting too much certainty in notoriously uncertain classes of business. This fear is also shared more widely across the European insurance market.

The CEA says that it is concerned that a lack of understanding about high-risk insurance business may lead to the arbitrary allocation of high levels of capital. This, the CEA argues, could lead to a poorer choice for consumers with high prices and a lack of competition.

In particular, the CEA points to the EC's aim of putting in place a regime that will ensure a 99.5% chance of an insurance company surviving after paying losses out in the first year after a major claim. This does not suit some high-risk classes or major catastrophes, according to the CEA.

One voice

On the point about having to undo what is currently being put in place, UK insurers will be reassured to hear that some people in Brussels are talking their language.

Jonathan Evans, MEP for Wales, and a member of the European Parliament committee that will be asked to pass the directive, acknowledges these fears.

"What people in the UK don't want is to implement the UK regime laid down by the FSA, and then find it subject to fundamental review by Europe." says Mr Evans. "The professed aim of Solvency II is to create transparency, while the FSA approach is to give ownership of risk assessment to company boards. These two approaches are perfectly compatible."

Over at the insurance and pensions unit, officials also appear to be in agreement, with one telling Post Magazine: "One of the main aims is to put responsibility back where it belongs - with company management. There are too few proper incentives to manage risks in the current regime." Indeed, this comment could have come from the FSA itself.

On the second fear about the new regime being too prescriptive when it comes to high-risk classes of business, EC officials are also making sympathetic noises. They will be looking to work with the market to calibrate the effects of the directive in advance of its publication. "In particular, this will look at some of the issues raised by the more risky, catastrophic risks," said an official recently.

EC roadmap

So, where has all this actually got to in the dense and seemingly impenetrable world that the European Union operates in? According to the latest roadmap produced by the EC, the key conversations at the moment are with CEIOPS about how the simulations of the impact of the proposals will be carried out. These are due to be worked on by national regulators this spring - after which the Internal Market Directorate of the EC will start work on the technical elements of the proposed directive, while CEIOPS supervises a second round of market simulations.

The actual draft directive should see the light of day in October. This forms the basis of fuller consultation, before a final version is adopted by the EC in July 2007. It is then handed over to the politicians in the European Parliament, where a minimum of six months' worth of deliberations are expected.

This puts the best estimate for its incorporation into EU law at the end of 2007. Were this to prove accurate, it would leave 2008 for its adoption into national laws, followed by implementation sometime in 2009. Bearing in mind this process started with a review of EU insurance solvency rules in December 1999 - that is a decade-long gestation period.

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