Solvency II is a new regulatory framework for insurance companies in the EU that replaced Solvency I. It aims to establish a risk-based approach where capital requirements are based on a company's risk profile. Solvency II introduces three pillars: Pillar 1 sets capital requirements; Pillar 2 focuses on risk management and governance; Pillar 3 addresses transparency and disclosure. While primarily affecting EU insurers, Solvency II may also impact non-EU subsidiaries of EU companies and EU subsidiaries of non-EU companies. Implementing Solvency II requirements like data management, ownership, and quality metrics poses challenges for insurers.

1. A summary of Solvency II Directives
Author: Sankar Aiyar
Coauthor: Shailesh Karia
Background
In 1973, the Solvency I Directive was put in place by the European Union (EU). It was aimed at revising
and updating existing EU Solvency regime.
However, it became clear that a more wide-ranging reform was required. 1
Over its 40 years of
existence, the 'Solvency I' regime showed structural weaknesses. It was not risk-sensitive, and a number
of key risks, including market, credit and operational risks were either not captured at all in capital
requirements or were not properly taken into account in the one-model-fits-all approach.
The Directive governing how insurers are funded and governed took more than 10 years to reach the
stage of enactment. The Solvency II Directive, along with the Omnibus II Directive that amended it
became a law on March 31, 2015. On April 1, 2015 the approval processes began, and after years of
delay and negotiations, the Europe-wide capital regime for insurance companies came into effect on
January 1, 2016. Insurers will have to comply with new rules and capital requirements of Solvency II
across the EU.
Here is a short summary of what Solvency II is and how it’ll impact financial services institutions in the
US (most of which are deemed to have fully or partly equivalent rules2
) along with EU.
What is Solvency II?
Solvency II introduces new and robust frameworks for insurance firms in the EU based on the risk profile
of each individual insurance company with the objective to promote comparability, transparency and
competitiveness. Solvency II amended under Omnibus II Directive 2014/51/EU replaces the existing
directives known as Solvency I.
The main aim of Solvency II is to contribute to the objectives of the EU Financial Services Action Plan
(FSAP) by encouraging a deeper single insurance services market that enables EU companies to operate
with a single license throughout member countries and ensure a non-zero failure regime i.e. there is a
0.5% probability of failure. Insurers will need enough capital to have 99.5 per cent confidence they could
cope with the worst expected losses over a year. The rules take a risk-based approach to regulation: the
riskier an insurer’s business, the more precautions it is required to take.
1
Lloyds Bank- About Solvency I
2
Financial Times- Q and A: How Solvency II works

2. The Solvency II framework, like the Basel framework for banks, proposes to remedy identified
shortcomings. It is divided into three 'pillars':3
 Pillar 1 sets out quantitative requirements, including the rules to value assets and liabilities (in
particular, technical provisions), to calculate capital requirements and to identify eligible own
funds to cover those requirements;
 Pillar 2 sets out requirements for risk management, governance, as well as the details of the
supervisory process with competent authorities; this will ensure that the regulatory framework
is combined with each undertaking's own risk-management system and informs business
decisions;
 Pillar 3 addresses transparency, reporting to supervisory authorities and disclosure to the
public, thereby enhancing market discipline and increasing comparability, leading to more
competition.
Who is affected?
Direct Implications:
 The European Insurance Industry including reinsurers
 Global insurance firms with operations in Europe
Indirect Implications on US insurance industry:
 US subsidiaries of an EU parent: “Major” (i.e., significant to the group) non-European
subsidiaries will likely need to incorporate significant aspects of the Solvency II requirements
locally.
 EU subsidiaries of a US parent: Under Solvency II, upward group supervision is triggered by the
existence of an EU insurance company being owned by a non-EU parent company or group of
companies.
 Rating Agencies: Solvency II is driving some companies to build more robust capital models and
imposes higher standards of corporate governance and risk management. Rating agencies are
considering using these improved capital models to compare and assess companies across
markets and are putting more value on better-structured corporate governance models and
improved risk management4
Who will be involved?
 Middle management – insurance and reinsurance companies
 Risk management, compliance and reporting personnel
 ASF* employees involved in regulatory and surveillance activity
3
European Commission Press Release- Solvency II Overview – Frequently asked questions
4
KPMG Solvency II- A closer look at the evolving process transforming the global insurance industry

3. *Autoritatea de Supraveghere Financiara a.k.a. Financial Supervisory Authority
Solvency II Challenges and Scope
It is estimated that the one-off net cost of implementing Solvency II for the whole insurance industry will
be around EUR 3-4 billion5
. The effects of Solvency II are already being seen, one such example being of
Delta Lloyd, a Dutch insurer, which disclosed that its shares dipped by 1.5% in 2015. This change was
seen after it became clear that its solvency ratio under Solvency II was worse than what was expected. 6
Organizations should focus on the areas most important to success, such as:7
Establishing Source and Lineage of key data
Solvency II reporting relies on data from different functions and various data sources, which leads to
inconsistencies. A data directory might be expected to hold a list of all data items that are within the
scope of the Solvency II requirements, along with some definition or description of use.
A Solvency II data directory needs to hold a description of the usage of data items and their nature and
properties. It should set out the lineage, or data-flow, of these items from source to target. Quality
criteria, thresholds and checks for data items are also likely to be defined within the Solvency II data
directory. This process of setting up a well functional data directory with option to trace data lineage can
be challenging to financial firms that do not have any such systems in place.
Implementing Data Ownership
Implementation of a data ownership model can be equally challenging. If not properly defined, the use
of broad terms such as “data owner” can cause confusion, especially where data frequently changes
hands and passes through multiple systems and processes. Insurers must consider all facets of data
ownership, for example, who creates or produces data, who receives or consumes data and who is able
to change or update data.
It is important that individual roles and responsibilities are clear, and that those individuals receive
appropriate support and training to make the rollout a success. This usually requires a lot of manual
work, making it time-consuming, at the same time making it prone to human errors.
Building Robust Business Rules and Data Quality Metrics
It is important that organizations develop business rules that facilitate a comprehensive assessment of
the completeness and accuracy of their data by engaging with subject matter experts throughout the
business. Solvency II system requires a creation of a robust yet flexible system that can implement its
rules and data quality metrics in a concise manner.
A survey of insurers conducted by Insurance Europe that was released on December 15, 2015 found
that:
5
Impact Assessment report for the adoption of the Solvency II Directive, page 50
6
Insurance Journal- Dutch Insurer Delta Lloyd Still Faces Solvency II Uncertainties; Rights Issue Planned
7
EY- What's next – Solvency II challenges to come

4.  68% indicated that supervisors have imposed additional last minute ‘gold plating8
’ (25% increase
since June 2015)
 47% confirmed supervisors interpreted Solvency II in a conservative manner
 79% noted improvement in governance
 74% reported improvement in risk monitoring and identification processes
 63% thought data quality had increased 9
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Hexanika is a RegTech software company that provides software products for regulatory compliance
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Read more about Hexanika’s Smart Solution at: http://hexanika.com/smartjoin-big-data-governance-
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Contributor: Vedvrat Shikarpur
8
Gold Plating: additional last minute measures by insurers to prepare for Solvency II regime. Outlaw
9
Lexology- Insurance Europe Solvency II survey

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