Like all regulations before it, this story too begins with a report commissioned by a politician. This one was called the Mueller Report.
Sowing the Seed
In April 1997 the seed for Solvency II was sown by a report prepared under the chairmanship of Dr Helmut Muller, Vice-President of Bundesaufsichtsamt für das Versicherungswesen (insurance supervisory federal authority of Germany) at the time.
Dr Helmut Muller
Author: Dr. Helmut Muller
Description: Review of the current solvency regime at the time. explored how the regulation at the time was struggling to keep up with the sophistication developing in the insurance sector. The regulation they were looking to re-vamp was put in place pre-computer era - 1973 for non-life insurers and 1979 for life-insurers.
It only took the European Commission (EC) 4 years to digest the 102 page of the report and take action. In May of 2001the EC formally launched the Solvency II process. The proposed process split Solvency II development into two phases.
Phase 1, planned to be completed by early 2003, was focused on doing the design thinking around the new regulation. The second, more technical phase, was to focus on developing the detailed rules which will form part of the overall system.
This two-phase lends itself to the "Lamfalussy" process widely used in Europe for making policy, a process by which the political discussions around the design of the regulation are run in parallel to the work done on the implementation details. The Lamfalussy process is designed specifically to keep politicians away from the details – they are already a confused bunch as it is.
Firing the starter pistol
The opening gambit for Solvency II was put forward by KPMG in May 2002, setting the theme for what’s to come – thick padded documents - with a 243 page report. The report, sponsored by Jean-Claud Thebault at the EC, starts with a quote from Shakespeare:
My ventures are not in one bottom trusted, Nor to one place; nor is my whole estate Upon the fortune of this present year; Therefore, my merchandise makes me not sad. [meaning] Thankfully my financial situation is healthy. I don’t have all of my money invested in one ship, or one part of the world. If I don’t do well this year, I’ll still be okay. So it’s not my business that’s making me sad.
Knowingly or otherwise Mr. Thebault had referred to diversification effect, something that the banking regulators and the insurance regulators never see eye-to-eye on. Great start to cross-sectorial harmonization.
Description: here is some description. was commissioned by the EC it starts by disowned it in the first page.
The consultants remain responsible for the facts and the views set out in the report. Once you get past that nugget the 14 pages of the executive summary goes on to introduce a three pillar approach, which feel a little recycled given that the three lines of defense is another advent of consultants – two lines are just fine in our opinion but we’ll go down that rabbit hole some another time.
Ever wonder what the three pillars were first called – Pillar 1: Financial resources, Pillar II: Supervisory Review & Pillar III: Market Discipline.
The report called out the challenges associated with such a fundamental reform and warned about the issues with developing a ‘one size fits all’ approach to risk modeling for a considerable heterogeneity European insurance industry.
Just before going off on Christmas in 2002, chasing hot on the heels of KPMG, the European regulators published a report concluding that capital assessment is not just about the number but culture.
Lead by Paul Sharma, a merry band of 34+ regulators from across Europe published a
112 page report
Description: here is some description. as a Christmas present for the industry.
This group gave birth to what we know today as the Own Risk and Solvency Assessment (ORSA) process. We have met Paul and the man can effortlessly paint a picture with words. To us, this report is the bed-rock on which the entire framework of Solvency II developed.
It’s worth mentioning, amidst all this development the Commission released patches to the various life and non-line Solvency I directives during the course of 2002 which shall go unmentioned for the purpose of the Solvency II story.
CEIOPS December 2003
One year on and the Committee of European Insurance And Occupational Pensions Supervisors (CEIOPS) released their thinking on the internal controls and risk management practices that should be put in place by insurers.
The intent was to introduce a common set of “principles and recommendations at an European Economic Area (EEA) level, [which] should increase convergence of supervisory practices, in line with the Brouwer recommendations on financial stability and financial crisis management”. In essence it was putting flesh around the London Working Group's report on Prudential Supervision; sculpting the ORSA process.
By summer 2004 the “Internal Control” trend had bubbled up from the London working group and CEIOPS all the way up to the Commission, culminating in a request for more. That’s right, the politicians had heard enough to wet their appetite and wanted more. On the 14th July the EC formally asked CEIOPS for advice on 6 areas – no prizes for guessing what was on the top of that list.
That’s right – Internal control and Risk management, followed by Supervisory Review process (general & quantitative tools), transparency of supervision, investment management rules and Asset-liability management.
It’s probably worth mentioning that Solvency II reporting package – the QRTs, SFCR & RSR - all spawned from a single bullet point. The EC simply asked for a “common market statistics for benchmarking purposes both between undertakings and across jurisdictions” what the Commission and eventually the industry got in return is everything including the kitchen sink.
Van Hulle making calls
Clearly the EC was so excited about Solvency II that they moved their head of Financial Reporting & Company law to lead the insurance and pensions unit. Mr. Karel Van Hulle formally switched hats in November 2004. It took him less than a month to pick up the phone and make another call for advice from CEIOPS – though technically the cover letters were being signed by one Mr. Alexander SCHAUB.
This time, December 2004, the EC was asking CEIOPS to advice on 12 areas, twice as many as the first wave of advice. The second wave was more technical in nature than the first and covered:
- Technical provisions in life assurance
- Technical provisions in Non-life insurance
- Safety measures (MCR)
- Solvency Capital Requirements – Standard Formula
- Solvency Capital Requirements – Internal Models & Validation
- Reinsurance (as a risk mitigation technique)
- Quantitative impact study
- Powers of supervisory authorities
- Solvency control Levels
- Fit & proper
- Peer reviews
- Groups and cross-sectoral issues
This was the first time the term “Solvency Capital Requirements” was references in the context of Solvency II. Prior to that the capital needed by insurers under the regime-under-development was referred to as “target capital”.
Four months into 2005 and the EC fired across their third and final call for advice from CEIOPS on further five areas. For those counting, that 23 areas of advice
The areas covered by the third wave were
- Eligible elements to cover the capital requirements
- Cooperation between supervisory authorities
- Supervisory reporting and public disclosure
- Small undertakings
All these calls for advice were meant to help the EC pull together the Framework Directive, ear-marked to be released for Mid-2006. CEIOPS had till the 28th of February 2006 to deliver their advice – the clock was ticking.
With their plates full, folks at CEIOPS went to work designing the Quantitative Impact Studies (QIS).
QIS 1 spec was finalised and published in October 2005. QIS 1 mainly focused on the insurance balance sheet calculation, more specifically the calculation of the insurance liabilities (Technical Provisions). Like all Solvency II publications to date, this quantitative impact study request paid no mind to the other party. That’s right … the deadline for QIS 1 submission … 31 December 2005 – Happy new year folks.
Like any movie with sequels, QIS 1 cover letter teased about QIS 2 – coming in spreadsheets near you, spring 2006. As CEIOPS published the QIS 1 results in March [17th of March] 2006, it was already consulting on the QIS 2 specification.
In June 2006 CEIOPS conducted QIS 2 which focused on the other parts of the balance sheet (Assets & non-insurance liabilities) and started testing the waters for the Minimum & Solvency Capital Requirement (MCR and SCR). The deadline for insurers for QIS 2 submission – 31st July 2006.
Despite the fact that no one, and we mean no one, works in Europe during August CEIOPS published their results of QIS 2 towards the end of October 2006.
Elsewhere in Europe
While CEIOPS was busy running their QIS exercises the HM Treasury and the FSA were doing some thinking on our favorite topic – supervising insurance groups under Solvency II [November 2006]. The challenge with group supervision is to balance two competing views: is an insurance group a single economic entity within which risks are pooled and diversified OR is the group a collection of separate legal entities with segregated risks. I will resist the urge to describe this in detail but it is definitely worth a read.
For what’s it worth, we believe that this paper was FSA’s thinking on the application of the ICA (individual Capital Assessment) regime to insurance groups, taking them away from the much simpler IGD (Insurance Groups Directive) regime.
Cut back to Frankfurt and CEIOPS was busy with round three of QIS. In April 2007 they published the third QIS, this time looking to refine the calibrations from previous tests to gauge the impact on the industry. The most notable change this time around was the testing the impact of Solvency II to insurance groups.
Surprising? Not really, clearly the FSA had shared their groups paper with CEIOPS. This time the deadline for submissions was 29th of June.
The EC was keeping busy too. On 10 July 2007, the Commission adopted the proposal of recasting 13 existing Directives in the insurance and reinsurance sector into the one - Solvency II. There was lots of legal jiggery-pokery which we will skip over, and it’s not clear whether it was 13 or 14 directives that got consolidated. Ultimately the key takeaway was that this new super directive should come in force by the 1st of November 2012 – we all know how that ended.
In November 2007 CIOPS published the results of QIS 3. The one common trend emerging from all these QIS exercises – the number of pages CEIOPS taking to explain the results was growing by each report.
As the number of pages grew, so did the teams needed to look at the volume of words coming through from CEIOPS. Enter CRO Forum. A group that was established to discuss risk management back in 2004. Insurers attitude towards risk functions and CROs in general was not very much different than their attitude towards IT staff, people you call when stuff is broken otherwise don’t know, don’t care.