Solvency II is an EU directive that has survived Brexit in the UK. The legislation is the regulator’s attempt to make sure that insurance companies have enough capital to cope with underlying risks to their businesses. It is an attempt to ensure, for example, that you get paid from an insurance policy if your house burns down.
The aim of Solvency II at implementation was to harmonise insurance regulations across the EU by replacing 14 existing directives with a single set of rules to create a level playing field for insurers in different member states. It requires insurers to hold capital proportionate to the risks they underwrite, leading to more efficient use of resources.
There are three distinct pillars of Solvency II: Quantitative, Qualitative and Reporting. ‘Quantitative’ governs the rules for calculating Solvency Capital Requirements (SCR) and Minimum Capital Requirements (MCR). SCR reflect the potential financial losses an insurer might face under various stress scenarios, while MCR set minimum levels of capital that insurers must hold as a buffer against unforeseen events.
‘Qualitative’ focuses on internal risk management and governance. Insurers must have robust systems and processes in place to identify, assess, and manage risks effectively. This includes the Own Risk and Solvency Assessment (ORSA), where insurers assess their own specific risks and demonstrate their capital adequacy.
‘Reporting’ states that insurers must publicly disclose information about their financial position, risks, and ORSA results. This allows regulators and policyholders to assess an insurer's solvency and make informed decisions.
Solvency II is far from perfect: it’s very complex and there’s an endless debate about the degree to which subjective judgement should be allowed. The UK government is in the process of reforming the regulation in order to improve it.
