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Next year the European insurance industry faces its biggest shake-up in decades. By the end of 2012 the EU’s Solvency II Directive is expected to go live after almost four years of proposals, counter-proposals, consultations and political wrangling.
Solvency II will change the way insurance companies operate. It was first mooted in the wake of the financial crisis in 2008 and its aims are simple: to protect policy-holders, limit consumer loss and reduce market disruption.
The directive itself is far from simple. While the new regime is still being finalised, insurance giants such as MetLife Assurance have been preparing themselves for some time. MetLife’s head of legal and compliance Stephanie Fuller has been working alongside an array of consultants, actuaries and other colleagues.
“If you don’t have plans in place by now, you really are on the back foot,” she says.
Solvency II, which applies to all insurance and reinsurance firms with income of more than E5m (£4.2m), will overhaul insurance companies’ capital requirements, with most commentators expecting them to rise. Calculating what those requirements should be is tricky at the best of times, and for MetLife it is even more so. When it comes to Solvency II, it is a case of the more complex the company, the more complex the requirements.
As well as being the biggest life insurer in the US, since it went public in 2000 MetLife’s presence outside the US has grown significantly.
Preparations were further complicated when last year it acquired AIG’s foreign life business Alico for $16.2bn (£10.1bn). “Our experience has probably been a bit more painful because we’re integrating a huge business too,” admits Fuller.
The group’s solution was to establish a holding company to ringfence its European operations. Had it not done this, its capital requirements and risk exposure would have been distorted by its global operations.
“The big challenge for us is establishing the holding company from scratch, and that means looking at how the European business fits into the rest of the group,” says Fuller.
Much has been made of the new capital requirements, but there are two other pillars to Solvency II. Companies must show they have adequate systems of governance, risk management and compliance. They must also show these are used in decisions that move the business forward. Again, the larger the company, the more complex the risk structure.
Companies also face new public disclosure and regulatory reporting requirements aimed at promoting greater transparency, which the FSA describes as a “more intrusive supervisory process”.
“We need to demonstrate good governance anyway,” says Fuller. “When the proposals came out we did an assessment and we’re pretty well-placed. It’s an opportunity to step back and re-examine governance models, make sure they’re fit for purpose and give effective oversight.”
This involves reviewing day-to-day management controls as well as risk and compliance committees and internal audit controls. Despite the work involved in preparing for Solvency II, Fuller is in favour of the changes.
“It makes sense that, following the crisis, we take a hard look at risk and solvency so it isn’t repeated,” she says. “It’s not a bad thing at all, and we’ve known it’s been coming for a long time.”
Last November insurance companies took part in the fifth Quantitative Impact Study (QIS5), an exercise intended to give them a feel
for how they will cope when Solvency II goes live.
The studies are also intended to help companies decide whether to use the standard model for meeting Solvency II requirements or the more elaborate internal model.
Generally speaking, the standard model is likely to be adopted by smaller companies. It will also depend on the amount of capital the standard model requires them to hold.
“For complex insurance groups the standard model wouldn’t be right - it’s probably a bit too simple for them,” says Fuller.
For the internal formula, companies will submit a model to the FSA, which will then assess it. In exceptional circumstances when a company’s risk profile is believed to deviate from the standard formula, it can be forced to adopt an internal model under Article 119 of the directive.
With well over a year to go until the new regulations are implemented, much remains undecided, meaning there is plenty more work to be done.
“It’s a massive project, particularly alongside the acquisition and bringing the two firms together,” says Fuller. “Ordinarily, if you made that kind of acquisition you wouldn’t have to do all that work in two years. Now we just have to get on with it.”