Solvency II capital requirements increase by 62%

Raj Ahuja - EMBThe UK non-life insurance industry will have to find, on a conservative basis, an additional €15bn of capital.

Consultants EMB have estimated this from analysis that shows these firms face an average increase in their solvency capital requirement (SCR) of 62% compared to the Solvency II QIS4 standard formula level.

This, says EMB, is the result of changes proposed to the implementation measures for the European regulatory standard over the past six months.

"This doesn't mean these companies are undercapitalized or have to raise fresh funds," stressed EMB partner Raj Ahuja. "It just means that their free capital [above the SCR] is reduced." But he added, "Some might decide to find more capital or merge with another firm."

It's likely that the CEIOPS' changes will also affect life companies but the EMB analysis didn't cover that sector.

The analysis was based on data supplied by 49 entities with a QIS4 capitalization of €8bn and shows an average 55% increase for personal lines firms, 61% for commercial lines and 66% for London Market firms.

The levels of increase for individual entities range from 10% to 120%. P&I clubs will be hit particularly hard if the Solvency II standard formula calculations remain in their current form with an average 92% increase across the entities surveyed. This could have more general economic implications, given the P & I clubs' domination of the marine insurance market.

The increases are likely to deter more insurers from opting for the standard formula under Solvency II. "For those teetering on the edge of a decision, it just got easier to go the internal model route," noted Ahuja. "And those who have already decided will be vindicated." He pointed out that the standard formula can be changed at any time by the regulators. Far better to have your own internal model which can be modified according to your own business requirements. He strongly advised firms to validate the effects of the CEIOPS' changes by taking part in QIS5 later in the year.

The impact of the CEIOPS' changes has been "indiscriminate", according to Ahuja: "Everyone seems to have been caught out by them." Differences in size and company structure have made little difference. "Larger firms are affected just as much as smaller ones," observes Ahuja.

EMB's analysis was unable to include all the updates to the standard formula implied by the CEIOPS papers but focused on those that it considered were likely to be more material to the overall result and where direct comparisons could be made.

By far the biggest impact it found arose from the changes in the calibrations of non-life premium and reserve risk which, in some cases, have been doubled. These account for 43% of the overall capital uplift.

The removal of geographic diversification benefits adds a further 5% to the capital requirement. This is a particular issue for many smaller UK companies, a lot of whom, unlike the majority of their European peers, write international business. The reduction in capital diversification on catastrophe and non-catastrophe risk exposures contributes a further 5% to the uplift. Increases in the operational risk allowance, as a result of a doubling of the factors in the formulae, also add a further 5% to the overall result.

Of the 49 firms participating in the study, 17 had a QIS4 capitalization of under €50m, 23 between €50m and €250m, and nine in excess of €250m. The participants were split roughly two-thirds and one-third between London Market and commercial and personal lines providers.

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