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Insurance Standards in the Solvency II Directive

April 17, 2012 | Comments: 0 | Views: 148

Insurance standards that are to take effect once the Solvency II Directive is implemented in 1 January 2014 must be studied by policy holders, insurance companies, managers, business owners and everyone included in choosing an insurance policy. Insurance standards are also called implementing measures which are basically requirements that will apply to issuers.

The three main pillars of the Solvency II Directive are made to help the framework of the new directive easier to understand. Pillar 1 is the quantitative requirements that an insurer has to abide to; Pillar 1 is all about the technical provisions of the new directive along with the Solvency Capital Requirement with the use of a standard formula developed by the regulators of the Solvency II Directive or a formula from an internal model developed by the insurance or reinsurance company.

The value of the technical provisions for the Solvency II Directive is calculated this way; these are excerpts of the specific prohibitions included in the directive:

  • The value shall be equal to the sum of a best estimate and a risk margin.
  • The best estimate shall be in accordance to a probability-weighted average of future cash-flows with the time value of money taken into consideration with the use of a relevant risk-free interest rate term structure.

As well as these methods of determining the value of the technical provisions of the new directive "the best estimate shall also be calculated gross without the deduction of the amounts recoverable from reinsurance contracts and special purpose vehicles. Those amounts shall be calculated separately."

  • Insurance and reinsurance undertakings shall value the best estimate and the risk margin separately.
  • Where insurance and reinsurance undertakings value the best estimate and the risk margin separately, the risk margin shall be calculated by determining the cost of providing an amount of eligible own funds equal to the Solvency Capital Requirement necessary to support the insurance and reinsurance obligations over the lifetime thereof.

The International Actuarial Association has a deep role in developing insurance standards, technical provisions and risk margins. The International Association of Insurance Supervisors has requested help from the IAAA to develop a better formula to assess risk based capital and risk margins for loss reserves. The collaboration of the IAIS with the IAA has led to the development of properties of risk margins which are namely the following:

  1. The less that is known about the current estimate and its trend; the higher the risk margins should be.
  2. Risk with low frequency and high severity will have higher risk margins than risks with high frequency and low severity.
  3. For similar risks, contracts that persist over a longer timeframe will have higher risk margins than those of shorter duration.
  4. Risks with the wide probability distribution will have higher risks margins than those risks with a narrower distribution.
  5. To the extent that emerging experience reduces uncertainty, risk margins will decrease and vice versa.

Pillar 2 on the other hand is all about the qualitative requirements for the governance and risk management of insurers. It is also for the effective supervision of insurers. It includes a system of governance together with an ORSA (Own Risk & Solvency Assessment) and a supervisory review process. Insurance firms are asked to make an assessment of their own solvency needs. The ORSA will function as an internal risk assessment process and a supervisory tool for the industry. Assessment of your own risk promises to be the best practice to improve the entire insurance industry; insurance firms who are able to use the ORSA will gain competitive advantage over other companies in the future.

Finally, Pillar 3 focuses on disclosure and transparency requirements of insurers. These include annual publication of each company's solvency and financial condition report. These pieces of information must be disseminated to the firms' supervisors to be able to assess any changes on their system, to implement better governance, etc. Disclosure of solvency reports is made through regulatory publications covering the company's risk profile and the underlying technical provisions. Checks and balances are of course necessary to ensure all published data are accurate. Pillar 3 of the Solvency II Directive will further enforce a transparent relationship between policy holders and insurance companies improving the insurance market all the more.

Derrick King is an Author and writer for many websites including but reminds you that this article is not to be considered as sound financial advice it is the point of view of the author only. All major financial decision should be verified by an accredited financial advisor. Stay lucky.

Source: EzineArticles
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