Regulation is ultimately all about setting the right incentives. By laying down common principles for improved risk measurement and management, capital allocation, and disclosure of data, the new prudential Solvency II regime aims at ensuring that insurance undertakings are kept healthy and stable, thus protecting both the business as well as the policyholder.
Looking at how other regulators are addressing this, the Irish regulator has decided to overhaul its approach towards financial regulation and will adopt a mixture of rules-based and principles-based regulation. This calls for the level of supervisory engagement to be a response to the perceived inherent risk and impact of a particular firm or sector. In itself, this move highlights the stated position of the Irish regulator in being a strong advocate of the concept of proportionality that exists within Solvency II.
Likewise, the Malta Financial Services Authority (MFSA) is showing its sensitivity to the needs and composition of the insurance market and has placed the principle of proportionality firmly on its agenda. Within the ambit of captive insurance companies for instance, on the grounds of proportionality the MFSA is constantly trying to make a case for Malta at EU level and, in particular, we witnessed its involvement with the Irish and Luxembourg regulators in providing its contributions for simplifications for captives during the Quantitative Impact Study 4 ("QIS4") exercise.
This should augur well for the captive insurance sector and the application of Solvency II. The Irish regulator has come out saying that the requirements for companies to draw up their Own Risk and Solvency Assessment (ORSA) under Solvency II can also be interpreted in the light of proportionality, to the benefit of captives. In this respect, the regulator has expressed its commitment to adopt a "common sense" approach, in that captives will be permitted to develop ORSA material that covers the requisite ground in a fit-for-purpose manner. For this purpose, a number of captive companies have been requested to submit their ORSAs as a pilot to the regulator to pro mote a better understanding and to enable this process to be broadened to the rest of the industry.
Guernsey and Bermuda, renowned strong captive jurisdictions, have not taken a clear position yet as to whether they will go for Solvency II equivalence.
Obviously the decision whether to go for Solvency II equivalence will be informed by any reputational repercussions that this may have on the particular jurisdiction.
Regulators have taken initiatives to issue sector guidance in connection with various aspects of the Solvency II regime. These initiatives vary in frequency and intensity among different regulators. However, there are similarities in the thrust of such guidance.
For instance, the rigorous scrutiny of insurers' internal models is clearly of vital importance to regulators since the regime calls for a more challenging and assertive regulator when assessing the proposed internal models, particularly if significant reductions in solvency requirements are at stake.
On this issue, the Irish regulator is prepared to hand out "pass marks", subject to insurers having done a proper evaluation at their end. However, it feels that most local insurers' internal models still need refining before obtaining regulatory approval, this being largely attributable to the underlying poor data quality.
Locally, the MFSA issued a guidance paper on December 3, 2009, entitled "The Use and Approval of Internal Purposes for Regulatory Capital Purposes in Insurance". Similarly to other regulators, the MFSA, through this guidance paper, has provided the sector with the expected characteristics of internal models, as well as the required standards vis-à-vis data and statistical quality, calibration, validation, documentation, and governance. The concept of proportionality underlies the discussion throughout.
Governance issues are likewise topping the agenda of EU regulators. In this respect, the local regulator has taken a proactive stance, even more so than some of its European counterparts. This April, the MFSA issued its second Guidance Paper, entitled "The System of Governance under Solvency II", which is a focus on the requirements of Pillar 2 of Solvency II. The MFSA clearly states that "even though the new Solvency II governance requirements will only apply when the new regime enters into force, it is important for insurance undertakings to start implementing systems, processes and procedures with respect to the system of governance, if they have not already started."
Regulators are gearing up steadily. The Irish regulator has set up a dedicated policy team dealing with prudential insurance matters, aiming to enhance its commitment over time. The level of resources being devoted for the implementation of Solvency II is under the spotlight. Most regulators, including those of Malta and Ireland, have increased their complement of personnel with actuarial expertise and have notably stepped up their participation in CEIOPS.
While the regulators are gearing up, it is now for the industry to take it upon itself to ensure that it matches the regulators' expectations. Insurance companies are encouraged to perform Solvency II dry-runs. One point that the recession has driven home is that quality capital may not always be readily available and so it is in the insurance companies' best interest to anticipate any capital requirements they will need to continue operating under a Solvency II scenario.
Ms Bencini is an advisory services partner at KPMG in Malta and Ms Briffa is a manager in the regulatory and compliance advisory services team at KPMG.