Solvency II was introduced with a view to protect policyholders by setting stronger requirements for processes like capital adequacy, risk management and governance. This has far-reaching implications for insurers in the European Union (EU) in terms of the models they employ for capital calculation, setting and streamlining supervisory processes, as well as keeping abreast with reporting requirements.

1. White Paper
A Perspective on Solvency II
- Divya Prakash, Kaza Sree, Malini Pandi, Amit Khullar
Business and Technology Impact on the Insurance Industry
Solvency II was introduced with a view to protect policyholders by setting stronger requirements for capital adequacy, risk
management and governance processes. This has far-reaching implications for European Union (EU) insurers in terms of
capital calculation models, setting and streamlining supervisory processes as well as keeping abreast with the reporting
requirements. With the deadline for implementing Solvency II at the horizon, insurers need to take stock of the situation
and come up with a sound implementation plan. Infosys believes that technology can be a key strategic enabler for not
only providing tactical solutions; but also helping insurers revamp their entire risk infrastructure.
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2. Introduction
A European Union (EU) directive, Solvency II seeks to codify and harmonize insurance regulations across the 27 member
states, including the UK. The directive provides guidelines on solvency capital calculations based upon standard as well as
internal models. However the directive is not limited to solvency capital calculations but also encompasses and stresses on
internal governance, the risk management framework and reporting protocols.
Key Objectives of Solvency II
Solvency I was introduced in early 1970s with a view to facilitate the development of a single insurance market across Europe. It was
primarily focused on prudential standards of the insurers and did not include requirements for risk management and governance. In
contrast, Solvency II has a much wider scope as it introduces a comprehensive risk management framework for defining required capital
levels and implementing procedures to identify, measure, and manage risk levels. The key objectives of Solvency II are:
• Upholding Consumer Protection: Protect the interests of the most vulnerable stakeholders in the insurance ecosystem, which are
the policy holders. Solvency II will ensure uniform policyholder protection polices across the EU.
• Heightened Supervision: It has been observed that the recent corporate failures have been a product of poor risk management
and governance, rather than insufficient capital to back the firm. Hence, Solvency II stresses on increased supervision and better risk
management processes.
• Single Reporting Template: Standard quantitative reporting templates will be replacing a majority of the existing templates. This
will significantly reduce the reporting burden by eliminating 27 different reporting frameworks.
• Prudent Person Principle: This will help insurers widen the scope of their investment portfolios. The Prudent Person principle
introduced in Solvency II, removes restrictions on the asset types that an insurer can invest in. This freedom is balanced by the higher
scrutiny of the investment portfolios.
• Reduced Ad Hoc Reporting: Detailed reporting on a more regular basis as stipulated by Solvency II will reduce the number of ad
hoc report requests and the associated costs.
27th July, 2011 Amendments to transitional measures, illiquidity premiums, 3rd country equivalence and reporting requirements
recommended
1st March, 2012 Regulatory technical standards laid down for calculation of Solvency Capital Requirements (SCR*), Minimum Capital
Requirements (MCR**) & internal models
1st June, 2012 Complete the implementation phase for technical standards
1st July 2012 Complete the implementation of remaining standards such as information delivery to supervisors
1st Jan, 2013 Supervisory review of funds classifications, ancillary own funds, full or partial internal models and calculation method
of group solvency
1st July, 2013 Insurers expected to start calculating SCR, MCR and be compliant with Article 35
1st Jan, 2014 Full implementation of Solvency II
1st Jan, 2016 Last date when member states can allow insurers to comply with certain phase-in elements of Solvency II (e.g.
compliance with SCR, provided their balance sheet is less than EUR 500 billion)
* SCR - Is calculated by aggregating the impact of an array of stress tests categorized by type or risk, called ‘risk modules’
** MCR - Is considered to be a level below which the company will not be permitted to operate. It shall neither fall below 25 % nor exceed 45 % of the undertaking’s
Solvency Capital Requirement
02 | Infosys

3. Solvency II Framework
The Solvency II framework rests on three foundational pillars, which have been elaborated in the following table. These pillars have been
postulated with a view to establish a sound risk infrastructure covering aspects such as risk profile authorization, corporate governance,
supervisory reporting, market disclosures and solvency soundness.
Pillars Salient Features Description
Capital • Sound Financial • Regulators would expect insurers to have comfortable surpluses in the
Requirements (I) Numbers event of catastrophic losses. Insurers will have to spend considerable
• Solvency Capital efforts on valuation of assets and liabilities.
Requirements (SCR) • SCR is a new solvency standard which will be calculated on an annual
• Minimum Capital basis.
Requirements (MCR)
• SCR is calculated with a more risk-sensitive approach compared to the
MCR formula, which is considered as a lower solvency standard.
• SCR can be calculated using standard as well as internal models.
Governance & • Governance & • Governance processes will involve a supervisor who will assess the capital
Supervision (II) Supervision solvency condition, technically as well as subjectively.
• Own Risk & Solvency • ORSA is designed to be an internal risk assessment tool that should be
Assessment (ORSA) incorporated as part of the insurer’s business strategy.
• ORSA will continue to be enhanced and is likely to evolve as one of the
best practices in the insurance industry.
Disclosure (III) • Solvency & Financial • Solvency and Financial Report (SCFR) would have to be published
Reports publically, which would provide a qualitative as well as quantitative
• Supervisory & picture of the firm.
Quantitative Reports • Regular Supervisory Report (RSR) is meant for the supervisor and would
focus on qualitative and quantitative aspects of the undertaking.
• Quantitative Reporting Template (QTR) is meant for the supervisor as well
as public disclosures. It would provide technical details like MCR, SCR,
asset valuations and technical provisions.
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4. Business Impact on Insurers
Pillar I Pillar II Pillar III
Impacts Impacts Impacts
• SCR calculation will have to be • Insurers will have to design • In compliance with public
done on a continuous basis and their internal risk programs and disclosures, insurers will have to
should reflect the changing risk structures, in case they do not showcase its annual report on
profile of the insurer. already exist. solvency and financial conditions.
• Calculations should reflect risks • Insurers will have to set-up • Reports will cover aspects such as
under various categories such supervisory processes and hire risk exposure, concentration and
as: non-life, life, special health corresponding personnel who risk sensitivity.
underwriting, market, credit and will be responsible for evaluating • The Reports will also cover capital
operational. the soundness of the risk management details on MCR,
• Insurers will have to choose management frameworks. SCR, Provisions, Assets and Funds.
between a standard and an • Each insurer will also have to • There will be a big impact in
internal model, which depends ensure compliance with ‘Own the way data is collated and
on the sophistication of risk Risk and Solvency Assessment’ aggregated. Thus, insurers
calculation models. (ORSA) taking into account its will have to revisit their data
• It is expected that large unique risk profile, risk appetite management systems.
insurance companies would and business vision of the firm.
• Insurers will have to start building
need only 80% of their existing • Technology controls and checks strength in reporting capabilities
capital requirements. On the would have to be set to ensure from a personnel, technology and
other hand, small insurers would compliance with the above process perspective.
see their Return on Capital (ROC) requirements.
adversely impacted.
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5. Impact of Solvency II across the Insurance Industry Spectrum
Profitability =High, Capitalization = Fully Capitalized
Consolidated
• Already profitable and fully capitalized.
• In a position to acquire attractive but weaker competitors.
leaders
• Capability to invest in innovative products that will boost pricing.
• Have the financial muscle to expand into diverse customer and geographic segments.
Profitability =Moderate, Capitalization= Moderate
Complacent
performers
• Majority of these players are policy holders’ owned mutual fund firms.
• These firms may find their future growth slowing down due to capital constraints.
under
• Profitability post Solvency II implementation can be improved by moderating the riskiness of the portfolios
Profitability =Low, Capitalization = Under Capitalized
Re structuring
• First priority would be to fix the capital requirements above the solvency II’s threshold requirements.
candidates
• Additional Solvency II capital requirements could worsen the profitability of the already undercapitalized
firm, leading to the possibility of the firm being ousted from business
• Raising new equity capital would be difficult due to high cost of capital.
Profitability = Moderate, Capitalization = Moderate-Insufficient
Border Liners
• These insurers would be able to boost profits if they are willing to take additional risks.
• Would require additional capital to remain solvency II compliant
• Ironically, they might end up with lower profitability if they try to reduce capital short fall by withdrawing
from high risk - high return businesses.
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6. Implementation Approach
Solvency II appears to be a complex directive that will have to be implemented with sound planning and a great strategy. While, it
will equally influence business processes as well as technology investments, insurers will have to prioritize in order to optimize their
spending.
Get Your Act
• Insurers will have to work on more effective ALM strategies as the solvency ratios are expected to fall
Together
from around 200% (under Solvency I) to around 135% with Solvency II coming into force.
• Some of the suggested approaches are restructuring products with emphasis on life products, diversified
portfolio, cleaning out sources of unrequired risks.
• Big players can take advantage of the consolidation wave, where small insurers might sell off, as
complying with Solvency II capital standards becomes tough.
Sensitizing Finance
Units • The finance and actuarial units will have to be sensitized towards the Pillar I requirements, with the
choice between the internal/standardized model being the first step.
• Insurers will have to choose between the home-grown and off-the-shelf calculation engines. Nevertheless,
some IT expenditure will be inevitable, where the insurers will have to test run the technology platforms
and solutions before the compliance deadline.
Dedicated Focus on
Data • Insurers will have to assess the impact of Solvency Pillar III requirements on their existing data collection
and movement processes.
• Data management will take center stage with insurers having to verify that their data sources are correct.
Insurers will need to deal with a lot of data on assets, claims, reinsurance, and risk events.
Cover the Reporting
• All the above mentioned efforts should finally be streamlined to meet the reporting requirements of
Fronts
Solvency II. Insurers will have to invest in reporting dashboards for supervisory, regulatory as well as
market disclosures.
• Reporting should be backed by compatible analytics to derive meaningful insights for benefit of the
senior management.
• Insurers will also have to start ramping up their XBRL knowledge, which is a widely accepted standard
reporting language.
Finally, insurers will have to make sure that their culture, people and business processes are in sync with the approach
that is taken for Solvency II implementation. Technological solutions should be considered as value enablers, which
would help in removing the bottlenecks while implementing this directive.
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7. Technology Enablers for Solvency II
IT Enablers for Pillar I IT Enablers for Pillar II IT Enablers for Pillar III
Actuarial, capital modeling, and Risk management, data models, Reporting and analytics
risk management tools and integration
These tools help insurers Data integration and Business intelligence and
perform valuation of assets and management would become reporting applications are
liabilities. In comparison to Basel the cornerstones for the success essential to provide reporting
II, the liabilities play a significant of Solvency II implementation. capabilities and dashboards
role for the insurers. Capital Insurance firms would need to for decision makers. Moreover,
invest in data integration tools to
modeling and risk management the reporting tools should
extract, transform and load data
tools support identification of be flexible enough to allow
from disparate sources. Data
risk dependencies and allocation integration would have to be users to generate customized
of economic capital at different of optimum quality to support reports and should be able to
levels and risk types. functions like reporting, audit, support reporting at different
security and control. aggregations.
Conclusion
Solvency II has a much wider scope than Solvency I and hence, is viewed as
tedious and complex by the insurance industry. In reality, it should be viewed
in the light of pre-emptive efforts taken by regulators globally to avoid a
reoccurrence of the 2008 meltdown. Insurers should look at Solvency II as a piece
of the Enterprise Risk Governance infrastructure, which is becoming a reality
in many organizations. The regulation provides an opportunity for insurers to
review the financial, process, governance and data health at an organizational
level, which may help them plug inefficiencies that exist within the system.
Technology would be a key enabler in the entire exercise providing solutions for
implementing the 3 pillars of Solvency II. Insurance players with their vision well
ahead on the Solvency II implementation trajectory can benefit tremendously
by overhauling their technology around business and reporting processes
enabling them to build their insurance enterprise of tomorrow.
References • Solvency II – Understanding the Directive - An EMB report
• Solvency II IT Vendor Spectrum – A Celent Report
• http://www.lloyds.com/The-Market/Operating-at-Lloyds/Solvency-II/About/What-is-Solvency-II
• Solvency 2: Quantitative & Strategic Impact – A Morgan Stanley Report
• http://solvencyiiwire.com/solvency-ii-news-implementation-timeline-imf-report/2931
• http://www.bain.com/publications/articles/solvency-ii-rewrites-the-rules-for-insurers.aspx
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8. About the Authors
Divya Prakash Tarey is a Consultant with the Risk and Compliance practice for the FSI (Financial Services
& Insurance) vertical. She is a major in Finance with FRM Level I certification and has worked on areas like
top-of-house reporting, credit risk data warehousing and risk management in treasury operations.
She can be reached at Divya_Tarey@infosys.com
Kaza Sree Ram is an Associate Consultant with the Risk and compliance practice for the FSI (Financial
Services & Insurance) vertical. He has completed his PGDM from TAPMI with a major in Finance. Prior to
joining the Risk and Compliance practice, he has worked for Infosys’ Enterprise Solutions vertical (Amdocs
Clarify /Telecom domain). His areas of specialization include brand equity research and compliance practices
in the Asset Management industry.
He can be reached at SreeRam_Kaza@infosys.com
Malini Pandi is a Consultant with the FSI (Financial Services & Insurance) vertical and works for the
Insurance practice. She has done her MBA majoring in Finance and has previously worked for an Insurance
company in the capacity of an analyst. She has experience in General and Life insurance, healthcare payer,
new business, underwriting and claims.
She can be reached at Malini_Pandi@infosys.com
Amit Khullar is a Senior Project Manager with FSI Risk & Compliance practice. He has close to 13 years of IT
industry experience and all of it in financial services and insurance domain. He has lead major transformation
and consulting projects and programs for clients across the globe.
He can be reached at amit_khullar@infosys.com
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