The FSA has published a Discussion Paper (DP 08/4 Insurance Risk Management: The path to Solvency II) in order to begin the programme of preparation which will be required for the implementation of Solvency II. The paper highlights and explains the key elements of the new regime and identifies the actions that insurers should currently be undertaking in order to prepare for implementation.

The discussion paper gives some indication that the political agreement of the Framework Directive may slip into early 2008. Nevertheless, we should certainly anticipate that the Level 1 Framework Directive is given assent by the European Parliament and Council in the next few months. There is considerable pressure to ensure that the Level 1 Framework Directive is finalised to ensure that the October 2012 deadline is to be met by firms. The detail of the regime will mostly appear in the Level 2 materials which need to be agreed by 2011 in order that the final deadline is met.

When implemented Solvency II will result in a modernised, risk-based approach to the control of prudential risk within insurance and reinsurance companies in the European Union.

Key messages for insurers to take on board

The DP considers the key challenges that are expected to face insurers in their implementation plans. The FSA makes it clear that the senior management of insurance firms should start to consider the implications of implementation now if they have not already done so. A ‘key messages’ chapter is included in the paper which should be considered by senior management and is designed as a stand-alone document so that the content to be considered at a suitable board meeting.

The DP states that there are two key messages that management should take on board:

Although the new prudential regulation introduced under Solvency II will apply rules that are similar and consistent with key aspects of the ICAS reforms familiar in the UK, the new regime is expected to go further and to cover matters not currently included by ICAS

Firms should be making effective plans for the implementation of the new regime now.

Senior management are asked to consider how Solvency II will impact:

  • The firm’s systems of governance and reporting requirements
  • How the firm is able to demonstrate that it has adequate financial resources
  • The use and approval of internal models
  • The supervision of the firm under the new regime

Firms should undertake gap analyses now in order to aid their transition from ICAS to Solvency II. It is possible that there may be shortfalls which firms must be able to identify and take into account.

Firms will need to assess the potential quantitative impact of the new regime. Those firms which did not participate in the QIS4 exercise are advised to apply the spreadsheets to their business to consider the impact and to highlight any issues which might arise.

Where firms intend to apply their own internal models rather than the standard formula for the calculation of their regulatory capital, the FSA suggests that they apply a period of “dry-running” a model and risk management system to ensure the proposed internal model is effective and meets requirements. In the DP the FSA outlines a possible process which will allow firms to engage with the FSA prior to implementation in order to develop their internal models. The DP states that they intend to invite firms to indicate whether they will be applying for internal model approval by June 2009.

The new regime may require changes to the supervisory process. The FSA will consult on any changes to the supervisory process in the run-up to implementation. During 2009 the FSA will begin to engage with firms to ensure that adequate preparations are being made for compliance and that steps are being taken to ensure that they are ready for implementation.

Firms should take note that “special project fees” will be levied in order to assist the FSA to meet costs incurred in engaging early with firms in considering their proposed internal models. These fees will be levied in 2009/10 and 2010/11. The FSA will consult on these fees.

Until implementation in October 2012 the current provisions in the FSA Handbook and the ICAS will continue to apply.

Feedback on this DP is welcomed by the FSA until 31 December 2008. The FSA intends to publish a feedback statement in March next year. In the meantime, the FSA will contact firms in order to identify the relevant individual nominated at board level who will be responsible for implementation. In addition firms must confirm the suitability of governance arrangements and their preparations for implementation.

For further information: Insurance Risk Mangement: The Path to Solvency II

If you would like to know more about Solvency II please read our guide: Understanding Solvency II