Clash of the regulators

As the pace of the Solvency II process to reform European insurance supervision quickens, British and French regulators have clashed over the use of market-consistent solvency requirements, to the alarm of proponents of risk-based supervision.

Speaking at the European Insurance Association (CEA) conference in Brussels in November, UK Financial Services Authority chief executive, John Tiner, warned about potential threats to the introduction of market-consistent solvency requirements for insurers. The FSA has been a pioneer in this area, both through its realistic capital requirements and individual capital assessment (ICA) review process. Defenders of the current technical or book value solvency regime in Europe now appear to have retrenched, which has alarmed the FSA.

In particular, by picking away at the limits of market-consistent valuation, they have opened the door to including so-called prudence provisions within a market-consistent framework. As Tiner conceded, objections to market consistency led the Committee for European Insurance and Occupational Pensions Supervisors (CEIOPS) to consider applying a confidence level approach (set at 75%) to technical provisions, which is currently being tested as part of an impact study.

For Tiner and other proponents of market-consistent solvency, this approach is intended as an interim measure, to give the industry time to develop internal models, and share insurance risk data that might permit market-consistent valuation. According to Tiner, "The purpose of the defined-percentile approach is to serve as a temporary proxy for the market- consistent approach." Tiner was strongly critical of attempts to include prudential risk reserves within technical valuations, or apply additional prudential limits or floors beyond a defined percentile standard.

Two days after this speech, at the CEIOPS conference in Frankfurt, the FSA's opponents revealed themselves. In particular, Florence Lustman, secretary general of French supervisor Commission de Controle des Assurances, des Mutuelles et des Institutions de Prevoyance (CCAMIP) showed the depth of resistance to market- consistent solvency when she said: "I like to hear the word 'prudence'. I don't think a market in insurance liabilities exists."

A key figure in Solvency II is Karel van Hulle, head of the European commission's insurance and pensions unit, because it is this unit that will serve as a channel between CEIOPS and the European parliament where Solvency II will ultimately be signed into EU law. Questioned about the split over market consistency, van Hulle responded: "It's a more complex issue than that," before revealing where his sympathies lay. "Some people dream about markets every second, others are more realistic. We are going to reach a solution in any case," he said.

Not only does the traditionalist camp object to market-based solvency requirements. Internal models, strongly promoted by bodies such as the CRO forum, and supported by Tiner, have attracted suspicion. According to Lustman, "I have heard the argument for pure internal models, which would fit a given group. But how can we as supervisors assure policyholders that we regulate companies in the same way, if models are very different? Can 10 different internal models be equivalent for supervisory purposes?"

Charged with delivering Solvency II, van Hulle appeared partly sympathetic to Lustman's views. "What we want is a better assessment of risk by insurance companies, which should allow for more prudence - which is better for policyholders and society. Where possible we will borrow from our experience with banking supervision, for example with internal models. But we must realise from the outset that insurance is more sophisticated than banking."

Without an FSA speaker on the CEIOPS panel, it fell to industry representatives to defend market-consistent solvency. Mel Carvill, deputy general manager at insurance multinational and CRO Forum member Generali, said: "We must avoid a situation in which risk-based capital, which is a rigorous economic assessment of risk, must be covered by available capital, the amount of which is subject to discretionary prudential buffers and margins."

The president of CEA, Gerard de la Martiniere, was more forceful. "Supervision will have to change.We don't want old style prudence rules/floors within a risk-based approach," he complained.