Although Solvency II has been widely debated among buyers, insurers, brokers and regulators, plenty of doubts remain about the actual workings of the directive when it finally kicks in.

“There are still questions that concern insurance buyers,” said Stéphane Yvon, the Senior Financial analyst at EDF who chaired the meeting. “First of all, there is the fact that 10% of insurers that participated in the latest stress tests did not pass them. Insurance buyers will have to remain cautious when selecting their counterparts,” he added.

Many large corporations are still reportedly not sure whether they will be able to maintain their current self-insurance arrangements because of the tougher requirements of the Directive on captives, speakers agreed.

“We are still waiting to see the final calibration of Solvency II,” remarked Mr Yvon. “As of today, calibration of catastrophic risks is a concern for all players, and this is likely to have a big impact on captives. The proportionality principle must also be well balanced, so that captive companies are not excessively penalised,” he said.

Although the future for captives remains murky, some firms have already decided to act, according to Marine Charbonnier, the Director of Alternative Financing at broker Gras Savoye.

“In Luxembourg, some captives have been sold by their parent companies,” she said. “Not only because of Solvency II, but also because the insurance market has been soft. Some have set up captives for uninsurable risks and realised that it would be too heavy for them to manage their captives while respecting the quantitative and qualitative Pillar II requirements.”

She said that it is currently not possible to say exactly how captives will be effected once the new rules are in place but that a better understanding should emerge in the next couple of years. But, as things stand at the moment, captives look likely to be penalised, she added.

“In its current shape, Solvency II implies lower proportion of ‘market risk’ in the SCR for captives than for the market as a whole, as captives are usually very conservative and cautious in their investment policies,” she said.

“But when it comes to the SCR for non-life risks, the situation could become difficult. The way that non-life risks held by captives are weighted is not very logical, considering how cautious they are also with their underwriting of risks-–due to cat risk calculation,” continued the broker.

Miss Charbonnier also noted that rules about the concentration of risks do not take the peculiarities of captive firms into consideration and they could be negatively affected as a result. “Concentration risk for captives is over-sized,” she said.

The current European crisis could also means that certain aspects of Solvency II will need to change, according to Mr Azouz, especially those that deal with the weighting of risks for investments made by insurance companies.

“The directive has been drafted under the assumption that sovereign bonds were the safest assets one could think of,” he stressed. “Today we are seeing that this may not be the case. There will be consequences of this. We cannot be sure what consequences, but it is clear that the financial crisis will bring some changes.”

Mr Azouz also expressed concern over the pro-cyclical character of the prudential rules implemented by the directive. “It means that, when things are going bad, companies have to put more capital aside. So in times of crisis, when clients need more protection and financing, they are likely to get less of each. This is something that needs to be considered,” he pointed out.

On the operational side, Mr Azouz remarked that the major challenge for insurers right now is adaptation to the governance requirements of Pillar II. These are set to guarantee that insurers will properly evaluate the risks they accept.

“Pillar II will create a conceptual framework for risk appetite,” he said. “If things are done the right way, top managers of an insurance company will be able to determine the risk appetite of the firm, and it will spread through the organisation to the underwriters, who will know the limits within which they can do their businesses. It could provide a powerful tool to steer the activity balancing risks and profitability in a smooth and profitable way. But it will demand investments from insurance companies, that’s for sure,” continued Mr Azouz. But risk managers should not forget the reasons for Solvency II, such as the key aim to make insurance companies more stable and secure.

As a result of the Directive the industry should be better prepared to face future crises and buyers will more easily be able to compare the financial health of companies based in different European countries, attendees were told.

“It is very important for French firms that the authorities make sure that risk carriers are safely regulated,” said Mr Yvon. “This fact has become even more evident in these times of crisis.”

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