Solvency II - A compliance burden or an opportunity for the Swedish non-life insurance industry?

Abstract: Insurance companies and banks are of great importance to the economy, which is why their stability must be ensured. In order to prevent bankruptcies in the financial sector, these companies are subject to strict regulations, which set standards for risk management and the amount of reserve capital required. Such capital reserves act as safety buffers to protect the customers from extraordinary events. In the insurance industry, the reserve capital is referred to as the solvency margin. Solvency II is new set of insurance regulations that aims to set a common standard regarding solvency capital and risk management for insurance companies within the European Union. The potential costs and benefits of the regulations are of importance not only to insurance companies but also to those firms that offer services and products to the insurance industry in the field of risk management. Solvency II is often compared to the Basel II accord for banks, which had a strong business case in the way that banks could significantly lower their reserve capital and use it for other purposes. The question is, however, whether insurance companies can expect similar benefits from Solvency II. The purpose of this study is therefore to explain how the Solvency II regulations will affect risk management in the Swedish non-life insurance industry, and whether these changes can result in opportunities for insurance companies. This is achieved by studying the new regulations and conducting a number of interviews with insurance company representatives as well as industry experts. Four potential effects of Solvency II have been investigated: capital levels, insurance pricing, credit ratings and reinsurance. The findings of the study indicate that no obvious benefits related to the potential effects above can be realised by complying with Solvency II. The future capital requirements will come close to those already enforced by supervisors today, resulting in a minor change that can go both ways. Neither credit ratings nor reinsurance covers seem to become notably affected by Solvency II. As for insurance pricing, an increasingly sophisticated risk-based allocation of the cost of solvency capital provides the most notable opportunity of Solvency II, but at present, no conclusions can be drawn regarding the effects of such changes. On the other hand, Solvency II will put pressure on improving systems to ensure the quality and traceability of data. Thus, the actual changes in risk management practices are not expected to be substantial among Swedish non-life insurance companies, and it therefore seems unlikely that insurance companies would be willing to invest as heavily in reaching Solvency II compliance as banks have done in Basel II.