Corrado Baldinelli, secretary general of the Istituto per la Vigilanza sulle Assicurazioni
How has Solvency II changed the insurance industry in Italy?
Let's try to provide a picture of the market under three dimensions: market structure, investment policy and risk-taking policy, and capitalisation. As regards the first point, we have witnessed consolidation in the Italian market for some years, but it wasn't a direct consequence of Solvency II. This said, small companies might indeed be in a more difficult position to comply with the forthcoming rules. Therefore, unless they manage to reshape their business and leverage on niche markets to gain competitive advantages, there is a chance they will come under pressure to consolidate.
Second point: investment policy and risk-taking policy. Our periodic surveys have shown that the main groups are gradually moving to diversify their investments by increasing purchases of public and private sector securities outside Italy, mostly in the euro area. There is a move to reduce the level of concentration of certain asset classes. And this trend is also driven by the emphasis on risk diversification given by the new Solvency II regulation. Persistently low returns are affecting choices of companies in Italy as happens all over Europe. They are moving away from traditional life insurance policies, which guarantee a minimum return, towards products with no guarantee, which absorb less capital.
Third point is capitalisation. On average, the Italian insurance market is well-capitalised on a Solvency II basis. All the Italian insurance undertakings will meet the solvency capital requirement (SCR) starting from next January, with very few exceptions. We have entered into dialogue with these "exceptions" to ensure they recover a sound position before Solvency II becomes effective. Often these companies are small subsidiaries of large European groups, so the remedy is that the group allocates more capital to them. And I don't see any problem on that. It is worth underlining that a satisfactory level of capitalisation for the Italian insurance industry will be obtained without making use of the transitional measures envisaged by Solvency II regulation and widely used in other European countries.
What was your most memorable moment during the Solvency II negotiations?
I spent a great number of years working in banking and financial supervision. When three years ago the Banca d'Italia sent me to Ivass (the Italian Insurance Supervisory Authority) – with the responsibility to supervise the Italian insurance industry – the numbers I found there left me really surprised. The approval of an internal model of a big European insurance group is based on the examination of a huge amount of technical documentation. The Financial Times of last August stated that the volume and complexity of this documentation force supervisors to "sift through gigabytes of arcane details about the risk exposures of insurance companies". I would add that our analysts and actuaries are very clever, but limited in number. Another aspect to consider is the volume of regulations, guidelines, technical standards that need to be implemented. The whole story of Solvency II starts from a European Directive, followed by voluminous Delegated Acts, 17 technical standards from the European Commission and 702 guidelines from the European Insurance and Occupational Pensions Authority (Eiopa). The numbers give some idea of the complexity of the new regulatory framework.
Solvency II will come into force early next year. All of us, insurance companies and supervisory authorities alike, are working at full speed on the tools needed to calculate the new capital requirements for the different risk categories, the main novelty of Solvency II; these include standard formulas, internal models, and specific parameters. Supervisors need to grant insurers permission to use some crucial mechanisms – for example, authorisation for undertaking specific parameters or the acceptance of a certain impact of deferred taxes on the level of regulatory capital.
This technically very complex task has to be completed in a matter of months. We have tried to enhance the preparation of groups and undertakings to the new regulatory framework: we have provided guidelines to the industry on matters of both substance and procedure, relating to the pivotal elements of the three pillars making up the new framework. I'd like to mention two other relevant aspects: we need to start an open discussion on the implications of the high complexity of the new prudential framework; we need to ensure homogeneity / equal treatment in the different jurisdictions (a truly level playing field has not yet been achieved); checks should be conducted on some aspects of the regulation with a view to assessing their adequacy to ensure equality of treatment and the full awareness of supervisors in their prudential evaluations.
What will be the main risk management challenge for the industry in 2016?
Pillar II issues still pose bigger challenges than others. Solvency II has strict governance requirements – starting with the responsibilities of the board – on which the average company has a lot of work to do. The preparatory phase has been very useful, as it has raised awareness around the implications of the new regulatory framework for the business. The fact is that there is more to it than checking boxes; insurance companies must draw consequences in terms of product design, investments and efficiency of their distribution channels. Sound risk management and sound internal controls are key. There is still significant room for improvement here. The correct understanding of FLAOR/ORSA [forward-looking assessment of own risk/own risk and solvency assessment] is a big challenge. In particular, for those companies which apply the standard formula, supervisors have to analyse this document in depth and enter into dialogue with the board of directors and the risk manager to check if the effective risk profile is well described and perceived. And this is a very burdensome and time-consuming task.
A second point I'd like to mention is the collection of a huge amount of completely new data; undertakings are working at full speed to produce them, use them, and assure Ivass of the quality of their data. Ivass itself needs to be ready to collect and use them properly. We need to avoid a "garbage in, garbage out" exercise. If the new data do not have a high quality standard, no good analysis on risk exposures can be performed, and no good understanding of the effective level of capitalisation can be achieved.
A third point is related, more generally speaking, to persistently low interest rates. This scenario continues to be an important challenge both from the point of view of financial stability and of consumer protection. Low yields might provide incentives for search for yield, which would increase the riskiness of the portfolio, leaving insurers vulnerable to a potential re-assessment of risk.
There might be also an impact on profitability and this effect might require greater attention to the level of costs. Therefore more rigorous cost containment policies should be implemented. Italian insurers have not been particularly affected by persistently low interest rates. This is mainly because they have well-matched assets and liabilities flows.
(The video is a shortened version of the interview)
Channels:Solvency II
People:Corrado Baldinelli