As the deadline for publishing the fifth quantitative impact study approached in March, insurers could have been forgiven for thinking this would produce bad news. If the test run suggested a ramping up of capital at a time when the investor base for financial paper is hardly ravenous, problems could have been on the horizon. But, crucially, this has not happened. In fact by dint of using an internal model, a large diversified group will end up on capital levels almost identical to their Solvency I numbers (see The Final Hurdle, p12). Clearly there were some significant losers, but these were spread by geography and business type, and on average capital levels were not going to give shareholders a heart attack. But this does not mean there are no outstanding issues with Solvency II. The key message that Life & Pension Risk has received from the industry is that uncertainty over the exact shape of Solvency II is acting as a serious bar to firms pressing the green button on the investment programmes needed to meet the directive’s requirements. This uncertainty, however, does not appear to be troubling the banks (Solvency II Solutions, p31), which are gearing up to sell a raft of products to meet the directive’s requirements. In an environment where increasing risk management is the message, the development of a clutch of banking products is to be welcomed. But if investment banks’ insurance arms get fat off the back of Solvency II, the real question that has to be asked is if the directive is sticking to its economic balance sheet approach? Some risks are more economic than others, and while it is easy to feel sympathy for whoever has to come up with an economically rational approach for valuing long-dated liabilities in countries with short-dated bond markets, concepts such as operational risk are even more difficult to model. They must, however, be modelled but, as pointed out in Fits and Starts (p21), the sheer difficulty of capturing the unknown unknowns of operational risk is proving a major task for insurers. It would be easy to think that Solvency II is the only issue affecting the insurance industry, but outside the European Union practitioners are wrestling with different problems. One clear example is Russia (The Road Ahead, p16), where insurers are suffering from a different problem than meeting the demands of regulators. In this instance it is constructing products that meet their own risk management requirements and yet at the same time can provide strong enough returns to meet the extremely high (over 10%) interest rates available on bank accounts. The combination of massive economic potential and low insurance penetration rates have long seen Russia labelled as a land of plenty for insurers, but it’s difficult to see where sustained growth will come from in that market....
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