09 September 2009

Published in: Investment risk, Regulation - supervision

How level will the Solvency II playing field be?

Some in the UK fear the FSA will apply the directive more strictly than its continental counterparts. Will "harmonization" succeed? Jessica Baylis investigates.

The approval of the Solvency II directive by the European Parliament and Council earlier this year has been the signal for some UK insurers and their advisers to start finding fault with it. The recent heavy coverage in the press of the costs to the UK pensions industry of Solvency II has been the most prominent example of this. But critics have also attacked the way they perceive the directive as being applied.

A survey published by Watson Wyatt in July revealed that 80% of the UK non-life insurance industry believes that Solvency II will be implemented with more stringent requirements in the UK than elsewhere. This belief is substantiated by others in the advisory business. "A number of our clients think that approval will be stricter in the UK than elsewhere," says Andrew Cox, partner at Lane Clark & Peacock LLP. Much of this seems based on the reputation of the UK Financial Services Authority (FSA): "They hold the view that the FSA tends to take the gold-plated approach to regulation whereas some of the continental regulators will make it a bit easier to get things signed off."

The ICAS effect

The Individual Capital Adequacy Standards (ICAS) regime implemented by the FSA in 2005 is one factor that has contributed to this perception of the FSA. What's more, as Mark Chaplin, consultant at Watson Wyatt Worldwide, explains, many firms in the UK hoped that ICAS would mean they had less to do than their European counterparts. "The UK has struggled to reconcile the fact that they have done a lot of work on this, which is not true across the rest of Europe, and yet the rest of Europe is still expecting to get most of their internal models approved."

It is widely recognized that the FSA has been one of the most proactive regulators, leading the way with Solvency II: "Some people have expressed the concern particularly around the FSA writing to all firms and having this very lengthy dry run internal model approval process," Chaplin continues. This is perceived by some as an example of UK firms having to go that extra mile to jump through the same hoops.

In a similar vein, the FSA is well resourced, particularly with technical expertise. This has fuelled the concerns that FSA supervisors will be able to push that bit harder in the approval process, and require that bit more from the firms they regulate. For example, Cox says that people are noticing that FSA Advanced Risk Recognition Operating FrameWork (ARROW) visits are becoming more onerous. "Non-executive directors are being quizzed about their ICA models with pretty hard questions -- hard even for actuaries to answer."

The FSA's difficult position

Janne Lipponnen who leads the FSA's Solvency II project says, "We are, of course, aware of these rumours." But adds, "We are going to be implementing Solvency II and doing it to the same standard as Europe."

He is keen to point out that the pre-application process is voluntary and that it is not gold-plating: "It is us trying to help firms meet a challenging standard in a confident and co-operative way."

"I fear that on this issue, the FSA will probably by damned either way," he adds. "If we didn't put something in place to help firms achieve the standards, then we would be blamed for not helping them. Now that we are putting something in place which is voluntary, we are blamed for doing something which is outside the European context."

Janne Lipponnen of the FSA: "We are going to be implementing Solvency II and doing it to the same standard as Europe." 

The Association of British Insurers (ABI) supports the FSA on its approach to Solvency II. "The FSA will try to implement this properly," says policy advisor Sophie Lloret. "Given current circumstances -- Solvency II has been developed in the middle of a hurricane -- they will probably try and apply it in a more prudent way than they may have done a few years back. But that's not specific to the FSA."

She is not the only one to voice her support. Chaplin points out that the flip side of the argument is that the FSA is helping the industry as far as possible. "The FSA has been very good at engaging with the industry, trying to understand their views and trying to advocate their concerns where possible. This is possibly something we haven't seen from the other supervisors."

Eating up management time

Not everyone is as convinced though. "I suspect that [the UK] will have to spend more management time on being with the regulator," Cox argues. "The FSA is in a better position to ask questions and that's just going to eat up valuable management time that probably would be better spent on making strategic decisions and trying to run the insurance company."

Val Amos, group head of risk at Hiscox, says there have been no concrete signs as yet that standards will be higher, but believes the industry is right to pressure the FSA to ensure it does not happen: "I was thinking about operational risk under Basel II. There were far fewer approvals from the FSA than there were in other countries, which suggests that maybe there is a higher setting." Amos says it's important to "keep the FSA on their toes" to make sure the concerns do not become reality; otherwise it could make doing business in the UK more costly: "This is obviously a concern as it could drive companies to relocate their head office outside the UK - either to Europe or countries like Bermuda."

Harmonization across Europe is the aim

Alberto Corinti, deputy director general and economics and finance director at the European Insurance and Reinsurance Federation (CEA) says that the most important thing is that the requirements are equal across Europe. "One of the main objectives of Solvency II is to create harmonization across Europe," he points out. Whereas the present Solvency I is a minimum harmonizing regime, Solvency II is going to introduce a harmonized regime where individual countries are not expected to go beyond the standards set by the legislation. "This is very important for Solvency II and is completely supported by the industry," he explains.

He does acknowledge, though, that it may take a while for supervisors' different day-to-day attitudes to harmonize. In the meantime, however, Cox argues that "for two to three years [before attitudes even out] UK companies will have to spend more on Solvency II compliance and jump through more hoops and will be at a competitive disadvantage to some of the other European regulators who maybe take a softer line."

Adding to UK insurers' concerns has been the issue of how some of the capital requirements of the directive will affect annuity portfolios, an issue which has provoked a lot of press comment over the last two weeks. The ABI is lobbying to water down rules that will harm insurers' annuity business [see box]. On this matter, the FSA is known to support the ABI and is keen to prevent the UK having added capital pressures.

These concerns point to the wider issue of how to ensure there is an even playing field across all Europe come 2012. "It's going to be very hard to make Solvency II harmonized," David Paul, director at Ernst & Young warns. "If you provide a mathematical formula across Europe then everyone will do it the same way but as the process is quite qualitative, it's going to be tricky to manage."

His colleague Rodney Bonnard, partner at Ernst & Young, agrees. "The interesting thing will be how they harmonize the different cultural emphases in different parts or Europe. What could well be the case is that there are different emphases on different elements of Solvency II. This is not to say that will make it easier or harder but you will have different interpretations of the rules."

The Committee of European Insurance and Occupational Pensions Supervisors (CEIOPS) is well aware of the challenge. Carlos Montalvo Rebuelta, its secretary general, says he hears the concern that standards will not be consistent voiced in most countries. "I'm not sure if the concerns are legitimate but they are understandable just because everyone is having the same concern that their country will have stricter requirements, or they will be applied in a stricter way by their national supervisors. We are aiming to have a high level of harmonization and we are optimistic it is possible."

Carlos Montalvo Rebuelta of CEIOPS: "Everyone is having the same concern that their country will have stricter requirements, or they will be applied in a stricter way by their national supervisors." 

Montalvo stresses that CEIOPS is not complacent, however. "The concern is there and we know it is there. We are doing a lot of work to ensure harmonization is achieved." By way of example, he mentions the convergence committee that was created two years ago to increase communication between different regulators and foster the creation of a European supervisory culture in the area of insurance and pensions, as well as the 20 free training courses provided to supervisors each year that aim to achieve a common understanding of issues and supervisory practices. Level 4 of the Lamfalussy process is dedicated to monitoring the enforcement of directives and this, he adds, will be heavily focused on fine- tuning harmonization.

Many see it as important that the large European groups have a role in mediating this process - or acting as "policemen" as Chaplin describes it. Tom Grondin, chairman of the CRO Forum and CRO at Aegon says the members of the forum are aware that they are in a unique position to see the different approaches in regulation. "We try to have an influence and make sure that Solvency II really is a success. If there are material deviations from what's in the directive, then, yes, we would make that known."

He understands the concerns of the UK industry. "I'm not surprised that people bring this up. On Solvency II, the FSA appears to be further ahead than other European supervisors from a resources and ideas perspective. The FSA is starting earlier and, in the sense that the implementing measures are not yet decided, the FSA may be trying to hit a target that can move."

Regulators moving at different speeds

Ultimately he does not think that there will necessarily be a significant difference in costs for the UK: companies there could be better prepared which could save costs in the long run. He does believe that European supervisors need to be better coordinated. "The regulators seem to be moving at slightly different speeds. I think there's a case to be made that CEIOPS could have managed this in order to get supervisors to cooperate more about the timing. They could then learn from each other and move forward in a cohesive and collaborative fashion."

As it stands, the different paces may make a lot more work for the groups. Grondin continues: "We know of companies being approached for pre-application for internal models from several supervisors. But that's not the way it's supposed to work; you're supposed to do one pre-application for your internal model under a process led by your group supervisor." It's not too late for CEIOPS to change this, he says. There are still many more stages in Solvency II left to go and cooperation will be important: "It may be a case of the FSA slowing down a little bit, or it could be a case of other members moving a bit quicker."

It will be important for the industry to apply pressure on supervisory authorities to ensure that the countries participating in Solvency II move at the same pace, communicate, and most importantly, create an even playing field. "It's something to be concerned about, and I think that concern is the very thing that will drive the action to try and get the harmonization," Bonnard says. "I think the industry will help CEIOPS by providing input about how it thinks it will work practically and how harmonization can be achieved." The obstacles to achieving maximum harmonization, he stresses, are "not insurmountable."

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