Denmark to introduce Solvency II shocks to insurer capital requirements

Firms warn regulator against setting an unduly ambitious timeframe for implementing new standard methodology

The Danish insurance regulator is set to tighten the rules for calculating insurers' solvency capital requirements, in a move to aid the transition to the Solvency II regime.

Finanstilsynet, the Danish Financial Supervisory Authority (FSA), will unveil on Friday a draft plan to introduce in 2014 a standard solvency capital methodology for insurers.

The technical specifications of the new standard will be in line with those used in recent Solvency II quantitative impact studies.

Danish insurers currently have the flexibility to decide on the size of the shocks they use to calculate their capital buffers, in order to better reflect the firm's risk profile.

The proposed changes aim to ensure an equal level of policyholder protection, according to Per Plougmand Baertelsen, director of the life assurance division at Finanstilsynet.

"The current regime does not prescribe a standard methodology, so we can see some companies choosing different confidence levels. We can see one firm applying [for example] a one-in-200-year shock and another applying a one-in-50-year shock and this can lead to some differences," he says.

The Danish insurance industry has welcomed the regulator's aim of bringing the rules more in line with Solvency II, but has concerns about the rules' potential complexity and the short time for implementation.

"Implementing all the changes as of January 1, 2014 is an ambitious timeframe. We are worried about it and have pointed to some things that might not be possible to implement in time," says Jonathan Kahlke, consultant for regulatory affairs at industry association Forsikring & Pension, in Copenhagen.

The new requirements are likely to put the pressure back on insurers, after a period when some have relaxed their efforts to prepare for Solvency II, in response to repeated delays in the legislative process, say experts.

The proposed rules might result in an increase to capital requirements for firms that have been using lower stresses for their calculations, according to Simon Stronkhorst, head of the life practice for the Nordics region at Towers Watson, based in Stockholm.

The greater impact, he adds, will be on processes. For instance, those companies developing internal capital models are expected to have to do some significant additional work around documentation and validation, while they are still able use their models.

The details of the standard methodology have largely dominated the pre-consultation discussions between Finanstilsynet and the industry during the past few months.

The regulator has signalled it is ready to make concessions and allow insurers to make calculations in a more simplified way, as long as the shock levels remain as stringent as those in Solvency II.

Baertelsen says insurers will be allowed to use duration to calculate the impact of changes in interest rates. This way they will not have to recalculate the value of all assets with the stressed interest rate curve.

But the insurance industry still has some concerns. Forsikring & Pension says plans for insurers to issue similar statements for insurers' annual accounts and solvency assessment would be too burdensome, because of the legal issues involved.

"Since the goal of the supervisor is to ensure homogenous protection for the consumer, it is probably best to focus on the solvency statement and calculation first," Forsikring & Pension's Kahlke says.

The association is also urging the regulator not to make the treatment of counterparty risk too complex in the final version of the draft proposals. "The way it is in Solvency II is not easily implementable. It accounts for a little part of the risk and for a very big part of the calculations," Kahlke says.

Some suggest that the introduction of stringent capital rules ahead of Solvency II might be detrimental to the ability of Danish insurers to compete with their European peers. Jesper Dan Jespersen, partner at the insurance practice at KPMG in Copenhagen, says this could be especially troublesome for insurers operating across the Nordic countries.

"The internationally-based or cross-Nordic insurers are worried about the introduction of pan-European rules with a national twist, which will increase the administrative burden of reporting and maintain slightly different regulations across territories," he says.

Others, such as Forsikring & Pension's Kahlke, suggest that foreign firms are unlikely in the short term to take advantage of the higher capital requirements in Denmark to build market share.

"[Capital] requirements are already harder in Denmark than in other countries and we don't not expect to see foreign firms stepping into the market to take advantage of supervisory rules because, hopefully, we will have Solvency II in two or three years," says Kahlke.

In addition to its plans for a standard capital methodology, the Danish regulator is also unveiling proposals for a number of changes to national regulations in order to prepare for the introduction of Solvency II's interim measures in 2014.

Denmark will make a final decision on whether it intends to comply with interim guidelines to be issued by the European Insurance and Occupational Pensions Authority (Eiopa) at the end of the year.

Baertelsen says that the Danish FSA has not identified many gaps between the existing solvency regime in Denmark and Eiopa's proposals, which cover areas such as internal model applications, forward-looking assessment of an insurer's own risks and systems of governance.

However, he says, the regulator does not intend to comply with some of the guidelines on reporting from day one. "We will not ask firms to comply with all reporting requirements. For instance, we are not asking for a detailed list of assets. But we will be able to do it later," he says.

In the past few years, Denmark has implemented several elements of Solvency II ahead of schedule and before other European Union member states. In June 2012, it adopted Solvency II's method of extrapolating the long-term component of the risk-free curve used to discount liabilities.