Putting the dampener on

News that the draft framework of the Solvency II directive has been passed by parliament with the duration-based equity dampener, and without group support, has come as a blow to those in the industry who wanted a regulatory system based on economic reality, not pork-barrel politics.

But the negotiating team from the French Finance Ministry must equally be celebrating its smart move to capitalise on widespread opposition - particularly among the smaller members of the EU - to the group support issue by offering to kill it in exchange for the dubious merits of the duration dampener.

Others have struggled to get their views across, most notably the UK's Treasury. One UK industry figure said the Treasury's failure to gain an explicit reflection of illiquidity premium in the draft directive was reflective "of the fact they don't have any friends in Europe".

A country vote on the FSA's proposals taken at the tail-end of last year saw only a few loyal acolytes vote with the UK proposals - another UK figure punned that the 22-5 vote against "used up all the UK's capital in the Solvency II process".

A decision by the UK to offer dark threats, rather than constructive compromises, over the duration dampener issue was perceived as a major weakness. And it was the actions of another part of the UK Treasury in the dark days of October to make innovative use of the country's extensive anti-terror legislation that no doubt killed any lingering hopes of a group support compromise.

The decision to impound the assets of Icelandic bank Landisbank drove a stake through the heart of any attempt to convince some of Europe's smaller states to effectively outsource large parts of their insurance regulation to London, Berlin or Amsterdam. And the subsequent expression of economic self interest by European states looking for ways out of recession thwarted any attempt to resuscitate the beast.

The likelihood is that even without the dramatic events of Q4 last year, attempts to include group support would have faced an uphill task, but the inclusion of the equity dampener is more surprising. The concept that equities can be used to back liabilities beyond a certain duration was questionable even in the most benign markets. But given that global stock markets have plummeted so far and so fast since the start of 2008, it appears to fly in the face of the economically sound principle upon which Solvency II was supposed to be built.

One senior figure in the German insurance sector replied dismissively to the question of whether his opinion of the equity dampener has changed in the light of its inclusion in the draft framework. "No, it hasn't. My view, which I share with the entire non-French insurance industry in Europe, is that the equity dampener is a bad idea."

The German figure was not convinced that this was the end of the issue - although it is included in the level one directive, there is still an opportunity for it to be reformed at level two, when the decisions are made by insurance industry professionals and not politicians.

But the EU is a combination of 27 countries, 23 languages and more than 500 million citizens - the fact that an agreement has been reached is an achievement. And while the present form of Solvency II may not represent a giant step forward for countries such as Denmark and the UK, which already have risk-based solvency regulation for those still using Solvency I, it is a major improvement.

Insurance is all about managing risk, and Solvency II, even shorn of group support, and including the dampener, puts risk management at the heart of European insurance.