The need for EU-based insurers to develop and implement an enterprise risk management strategy in response to Solvency II was one of the topics at the International Insurance Society (IIS) 43rd annual seminar in Berlin in July. Jean-Paul Louisot reports

Although the Solvency II deadline has been pushed back to 2012 to allow all countries to be on board, it remains a very important project when combined with the implementation of the new International Accounting Standard. Both developments will change the approach to sustainability and solvency of the national control boards and the quotation agencies.

Jacques Aigrin, CEO, Swiss Re, launched the first CEO panel, a traditional feature in all IIS seminars, with strong words for his fellow executives. “The risk landscape has been changing quite dramatically in recent years and some key developments stand out. Event-driven risks are increasing in size; the interdependency of risks is growing, and stakeholder expectations remain high.

“At the same time, numerous regulatory, legislative and accounting initiatives on insurance and financial services have emerged. These trends demand continuous and close attention ... A modern regulatory framework is also a key condition for ensuring that reinsurers provide capital efficiently. For this reason, regulators, rating agencies, and accounting standards need to see the same economic and risk-based view of a reinsurer's financial strength. Harmonisation and mutual recognition of regulatory bodies are essential factors in making the market more efficient. We have seen encouraging progression the area with the Solvency II project in Europe. We expect that the EU directive will enhance the risk culture in the industry, and lead to a more rational and transparent marketplace.

“Reinsurance will continue to expand into wider forms of capital market solutions ... We are proud to have driven the development of the insurance-linked bond market and related instruments for both property and life exposures. Going forward, the industry, regulators and rating agencies need to work together to unlock the full potential of capital market solutions.”

Patrick Thiele, president and CEO of PartnerRe expressed his own similar views on risk sharing when, before stressing the merging movement of capital and insurance markets, he made the following points:

• a risk-averse society wants to off-load risk – illustrated by insurance premiums growing faster than GDP

• capital markets remain focused on return – illustrated by the limited application of risk technology, low credit spread (not enough reflection of risk factor), and growth in non-diversified vehicles (no spreading of risk)

• insurance is the primary adapter of risk management tools and technology, with very sophisticated application of insurance risk, and the driver of the illiquid, long tail nature of exposures.

Of course, the key to an end to cycles is probably that hoary chestnut 'underwriting discipline'. However, after analysing how the cycles in the insurance industry seem to be always linked with last year's good result, Leonard Battifarano, senior vice president AIU (AIG Group), had this piece of advice for his colleagues – stop looking in the rear mirror and adjusting your prices on the past, and look ahead to what might happen, especially when so many elements of the risk context are always changing. In a simple phrase, he summarised a principle which all risk management professionals would applaud: “Underwrite the exposure, not last year's loss history.”

One might say that this is precisely the intention behind the new Solvency II directive that was released during the seminar (on 10 July). If it was too early for delegates to comment on the text in detail, they may have been prepared to take Karel van Hulle, head of unit, insurance and pensions, DG Market of the European Commission, at his word when he professed that: “Solvency II is about offering a modern, innovative and liberal regime for the prudential supervision of insurers, based on sound economic principles.” Van Hulle also quoted the four objectives pursued by the proposed directive:

• deepen the single market

• enhance policy holder protection

“Risk based calculations will create an incentive for more integrated risk management

• improve international competitiveness of EU insurers

• further better regulation.

In his conclusion he remarked that Solvency II is “All about improving risk management and rewarding already existing good practice” and that “updating risk management processes and practices into a company takes time” before offering some “warning” advice to the practitioners in the room.

• Insurers need to start preparing now, if they do not want to be caught out when Solvency II comes into force (in 2012)

• The future will belong to those who prepare for it now.

For his part, Helmut Perlet, chief financial officer of the Allianz Group, saw some key issues and implications of Solvency II for his company.

• Risk based calculations will create an incentive for more integrated risk management (but large players have already developed sophisticated models for capital allocation).

• Convergence issues:

- to Basel II in Europe

- of supervisory approaches in the different member states

- with IAS/IFRS.

• Market consistent valuation of assets and liabilities.

“Clearly, holistic risk management tops the agenda of every insurance and reinsurance CEO

• Group supervision: who will be in charge?

• Increased transparency concerning supervisory practice and the business model of insurance companies.

Perlet identified some crucial factors on which the success of Solvency II will depend.

n Ensure that groups are supervised in line with their risk profile: Clearly defined lead supervisor concept with separation of roles and responsibilities; allowance for diversification.

• Level playing field independent of group location: Harmonisation of supervisory standards and practices across member states.

• Foster risk management best practices: Incentives to implement full internal models (more accurate than standard models).

• Avoid regulatory arbitrage: Supervision of sectors not covered by Solvency II have to be upgraded (ie pension funds).

• Ensure efficient reporting: The starting point for public disclosure has to be the future IFRS standard.

For his part, Jerry M de St Paer, executive chairman of GNAIE (Group of North American Insurance Enterprises), stressed that as his members are significant participants in the European and worldwide insurance markets they care about Solvency II. Their major concern over the convergence between the new proposed EU regime and the IFRS proposals really echoes Perlet's earlier comment about a level regulatory playing field; in other words, will Solvency II treatment of capital requirements for EU and non EU based companies create de facto competitive imbalance?

Whereas Solvency II and the US Risk Based Capital (RBC) frameworks differ in their approach to establishing risk-sensitive capital requirements, developments in the RBC for interest-rate risk and market risk indicate that the thinking in the field of risk quantification is reaching greater alignment on both sides of the Atlantic.

A meeting of minds may be accelerated by the major rating agencies, which are now including enterprise-wide risk management (ERM) criteria in their quality assessments. In his address to the IIS seminar delegates, Rodney Clark, director, insurance ratings, Standard & Poor's, stressed that “Risk management is at the heart of what Standard & Poor's does: we assess insurers' risks and how risks are managed. Previously, only qualitative credit was given to risk management practices and models; ultimately, we may give some quantitative recognition to risk models, but only where models are robust and underlying risk management framework is sound.”

Clearly, holistic risk management tops the agenda of every insurance and reinsurance CEO, as it seeks to attain the best risk/return blend: the efficient frontier that fulfils the shareholders' risk appetite.

Jean-Paul Louisot is directeur pédagogique, CARM Institute, Tel: +33 (0)9 52 49 60 80, Email :


Although the Risk Based Capital (RBC) standards in the US and the EU's proposed Solvency II share the common goal of protecting policyholders and strengthening insurers through sound regulation, in many ways they differ substantially. While Solvency II calls for a global, enterprise-wide risk-management approach, taking into account the company's risk profile (principle of proportionality), RBC focuses solely on capital adequacy.

For Solvency II, the commission has chosen a top-down, holistic approach with three supporting pillars:

Pillar 1: Capital adequacy through capital requirements on two tiers, a solvency capital requirement (SCR), and a minimum capital requirement (MCR)

Pillar 2: Risk management requirements with capital adjustments to the SCR in case of deficiencies

Pillar 3: Disclosure requirements to reinforce market discipline.

In Solvency II, risk management and disclosure requirements are equally important as capital adequacy. A fundamental difference between the two regulations is that Solvency II is based on economic fair-value concepts, while the RBC calculations are based on best estimates modelling rather than prudent statutory values.

The Solvency II top-down approach is designed to lead to a coherent system, which will bring together quantitative and qualitative risk management. This unified measurement approach makes risks more transparent for management, and further integrates risk and performance management.

The RBC bottom-up approach has the advantage of allowing for a quick implementation. In addition, the flexibility of using different time horizons enables long-term risks to be modelled more accurately than under Solvency II.

Source: Insurance Insights 2007, p54/64 – KPMG