Solvency II: What advisers can Expect

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With Solvency II officially in force, our Operations Director, Courtney Marsh, explains the implications for providers and the changes the market will have to adapt.

Now 2016 is upon us Solvency II is officially in force, with important implications for product providers and financial advisers. After initial uncertainty as to how Solvency II would apply to the health cash plans market, it has brought about significant change.

Solvency II is the EU Directive that is designed to harmonise EU insurance regulation across member states, in particular the amount of capital that EU insurance companies must hold to reduce their risk of insolvency. There are three main pillars:

  • Pillar 1 consists of the quantitative requirements (such as the amount of capital an insurer should hold).
  • Pillar 2sets out requirements for the governance and risk management of insurers, in particular the Own Risk and Solvency Assessment (ORSA) process.
  • Pillar 3 focuses on the requirements for disclosure and transparency.

Companies’ work on the first two pillars should be broadly complete, with most insurers now concentrating on the third pillar. Companies will need to get to grips quickly with the XBRL reporting (eXtensible Business Reporting Language) through the Bank of England’s BEEDS (Bank of England Electronic Data Submission) portal.

The deadline for day one reporting is just around the corner in spring (20 May 2016), with quarter one reporting due a few days later (26 May 2016). The deadline for reporting the first year end is 19 May 2017.

Firms will also need to produce their first Solvency Financial Condition Report (SFCR), Regular Supervisory Report (RSR), Quantitative Reporting Templates (QRT) and National Specific Templates (NST), however waivers are available for small firms on quarterly reporting and for all firms on the public SFCR.

Companies should have been through the ORSA process at least a couple of times and have an ORSA  report  available at the request of the regulator who is looking to review all firms by the end of 2016. Firms must also produce a record of the ORSA – this allows a third party to come to the same conclusions as the Board when signing off its ORSA report. Initial feedback on ORSAs from the regulator stated that ORSAs should include a clear summary of the data being reported on, specifically highlighting the key messages. The ORSA should not be too long, any supporting documentation should be sign posted and Board sign off of the ORSA should be included. ORSAs should also demonstrate whether the standard formula is applicable or not, and look at the emerging risks for the business, existing key risks and any management actions.

A wide range of stress testing should also be included, as well as reverse stress testing, alongside a forward assessment of a company’s own risks.

Although much of the reporting information produced will remain between the insurer and the regulator, Solvency II aims to deliver more transparency to all stakeholders. A good example of this is the Solvency and Financial Condition Report (SFCR).  The SFCR will be published annually and will be a publicly available document.  It will contain information on business and performance, systems of governance, the company’s risk profile, and a company’s solvency position both today and in the future.

Insurers will be able to apply for waivers to avoid releasing any commercially sensitive information.  However, the information contained within the SFCR will allow interested parties to obtain a much more informed picture as to how a company manages the risks it faces, the capital it holds and the underlying performance of the business.  It should therefore enable a more transparent comparison between insurers.

So what does all of this mean for advisers? One of the key benefits is that when insurers are designing or amending products they must be developed with consumers’ needs in mind. It will mean more stable pricing as insurers better understand the underlying risks and look to create a more stable inflow of income.

You may ask the question whether insurance products are in their nature designed to meet consumer needs. But demonstrating good conduct means that insurers need to be able to justify why new products are being brought to the market and why changes are being made to existing products. In simple terms, changes should be made with the consumer in mind and not simply linked to company financials.

In addition, much of the reasoning behind harmonising regulation through Solvency II is to promote confidence in the financial stability of the insurance sector and provide supervisors with an early warning so that any intervention can be promptly taken if a company’s capital falls below the required level. It also offers greater protection to consumers and should reduce any risk of an insurer not being able to meet its customer’s claims.

A company that is Solvency II compliant will have put in place a robust framework that analyses their risks and will have increased their in-house expertise of risk analysis to help them do so.

Solvency II has created major changes in the sector and, at Health Shield, we very much welcome it and believe it will be a force for good in the insurance industry. It forces insurers to embed actuarial expertise, long term planning and greater transparency into their financial planning process and product design. Companies will have to explain clearly where they are holding their capital, why they have made the decisions they have, and the associated risks that sit behind those decisions. For example, if a firm’s Board increased the risk exposure within its investment strategy it would need to justify the reasons, explain the additional capital requirements to stakeholders and perform thorough sensitivity and scenario testing to ensure the risk taken is not beyond the insurer’s risk appetite.

One expected consequence of the Solvency II rules is that there could be a surge of merger and acquisition activity in the insurance market. Some larger insurers are expected to look to diversify their offerings to customers, while smaller companies may be less able to withstand the volume of analysis and reporting required under the new rules. Combined, this makes way for many companies to seek to merge their services. The fact that all insurers across the EU have to report their capital position in the same way will only help the process.

We produced our first ORSA in November 2014, after planning for Solvency II for a long time. For years we have invested heavily in product development, risk management and actuarial capabilities. All business and capital management planning has used five year Solvency II projections since 2012, combined with a wide variety of stress and scenario testing to enable us to see what might happen in very different or turbulent times. It is only right from a customer perspective that financial firms have to submit themselves to this type of rigorous testing.

Trust has long been an issue in the insurance market and research from various providers in different sectors of the market continues to show year after year that people underestimate the amount of claims that are paid, and often the level of value they can get from insurance products.

People must be able to feel assured that the companies they buy products from are strong enough to deliver on their promises, that the company will still be around when they need it, and that the products they buy are properly designed to fit their needs. Alongside Solvency II requirements, initiatives like publishing claims stats can greatly help with consumer confidence if communicated well. Our last set of figures showed that we paid 97.4% of all claims, which continues to prove that people can put trust in the services they bought into when initially taking out a product.

Rather than seeing Solvency II as a directive handed down from the EU that causes great disruption and cost to the market, we should see it as an opportunity to prove to consumers the strength of our industry and the invaluable services we provide to people every day.