Home > News > 2002 > June 2002 > New solvency margin requirements for insurance undertakings
New solvency margin requirements for insurance undertakings
Simon Spencer, from the life insurance consultancy team in the London office, reports on new EU solvency requirements for insurers.
In October 2000 the European Commission published proposals to amend Council Directives 79/267/EEC and 73/239/EEC as regards the solvency margin requirements for life and non-life insurance undertakings respectively. These new Directives were adopted by the Council of Ministers on 14 February 2002, and entered into force when published in the Official Journal of the European Communities on 20 March 2002. These are the so-called "Solvency I" Directives.
What is the reason behind the changes?
The stated aim of the new regulations is to improve the protection of insurance policyholders by improving the rules regarding the solvency margin of insurance undertakings.
What are the timescales involved?
Member States must implement these Directives within 18 months of their publication in the Official Journal, i.e. by 20 September 2003. The new solvency requirements will then be applied to accounts for financial years beginning on 1 January 2004 or during 2004. However, Member States may allow a transitional period of up to five years from the commencement date of the Directives for undertakings to comply with their requirements. Even then, it is possible that a further two years may be granted for undertakings that have not fully established the required solvency margin.
The UK's regulatory body, the Financial Services Authority (FSA), originally consulted on how the Directives would be implemented in the UK in Consultation Paper 97. This was, however, based on an earlier draft of the Directives, and so more detailed comment is expected later this year in a feedback statement on CP 97. In particular, the timetables for implementation and transitional arrangements are still to be decided.
Summary of the main changes for life assurance undertakings
- The new regulations do not apply to mutual associations with less than EUR5m (previously EUR500k) of annual contribution income.
- The required margin of solvency must be satisfied at all times, rather than just at specific valuations. (This already applies in the UK.)
- The items (mainly assets) eligible to cover the solvency margin are split into three groups; those that may be accepted without limitation, those that are subject to some limitations, and those that may only be accepted with authority approval. (This already applies in the UK.)
- Where an item for future profits is calculated, the maximum factor for outstanding term is reduced from 10 years to 6 years. After 31 December 2009, the possibility of including future profits in the available solvency margin will cease.
- For PHI business written on a life basis the required solvency margin (RSM) is strengthened by the addition of the RSM for PHI business written on a non-life basis.
- For linked business previously subject to a 0% solvency requirement (i.e. no investment guarantee, no expense guarantee over 5 years) the RSM is to be taken as an amount equivalent to 25% of the last financial year's net administrative expenses pertaining to such business.
- All of the guarantee fund (previously 50%) will need to be covered by higher quality items.
- The minimum guarantee fund is increased to EUR3m from EUR800k. For mutual associations this figure is reduced by 25%.
- The minimum guarantee fund will be steadily increased in future to maintain its value.
- The regulators will have greater powers of intervention. Examples of this could include:
- requiring a higher solvency margin than stated by the regulations.
- revaluing downwards items covering the solvency margin.
- reducing the reduction allowed for reinsurance, particularly for financial reinsurance where there is little or no risk transfer.
- early intervention, i.e. before solvency requirements are breached.
Summary of the main changes for non-life insurance undertakings
- The new regulations do not apply to mutuals with less than EUR5m (previously EUR1m) of annual contribution income.
- The required margin of solvency must be satisfied at all times, rather than just at specific valuations. (This already applies in the UK.)
- The items (mainly assets) eligible to cover the solvency margin are split into three groups; those that may be accepted without limitation, those that are subject to some limitations, and those that may only be accepted with authority approval. (This already applies in the UK.)
- The method of calculation of the required solvency margin remains largely the same, but with the following changes:
- Premium basis
- based on higher of gross written and earned premiums.
- premiums to be increased by 50% for marine, aviation and general liability.
- premium threshold (up to which higher percentage applied) increased from EUR10m to EUR50m (18% below, 16% above).
- reinsurance deduction based on last three years claims (increased from one year).
- Claims basis
- claims to be increased by 50% for marine, aviation and general liability.
- claims threshold (up to which higher percentage applied) increased from EUR7m to EUR35m (26% below, 23% above).
- reinsurance deduction based on last three years claims (increased from one year).
- Where the volume of business is falling, the required minimum margin is based on the previous year's RMM reduced by the proportionate reduction in the level of technical provisions.
- The minimum guarantee fund is increased to EUR2m (or EUR3m for motor, marine, aviation, general, credit and suretyship). For mutuals this figure is reduced by 25%.
- The premium and claim thresholds and the minimum guarantee fund will be steadily increased in future to maintain their value.
- The regulators will have greater powers of intervention.
The future
The Solvency I regulations focus on strengthening the solvency position of insurance undertakings. The European Commission is now undertaking a wide-ranging project, known as "Solvency II", that considers the overall financial position of insurance undertakings. This may cover areas such as:
- Rules governing assets and liabilities
- Matching of assets to liabilities
- Reinsurance arrangements
- Implications of accounting and actuarial policies
- More sophisticated approaches to solvency
- Aggregation of risks
Work on Solvency II has begun, but given the scope of this project it will be a number of years before anything concrete emerges.
Simon Spencer, June 2002.