Lloyds on track to meet Solvency II challenge

Shake up
Solvency II will see the biggest shake-up in the way Europe’s insurance industry is regulated in three decades. The new rules are aimed at increasing insurers’ financial stability by introducing more sophisticated capital-setting requirements that take better account of the risks that companies face. The new regime, which will be implemented at the end of 2012, will replace the patchwork of differing rules that currently exist across the continent.

Although the framework was adopted by EU member states in April 2009, the detailed proposals have still to be worked out. Insurers are currently testing the latest draft rules in what is known as the fifth quantitative impact study, or QIS5. Lloyd’s has played an important role in discussions about what form the new rules should take and its 80-plus syndicates will take an active part in QIS5, using its proposed standard formula to work out what their capital should be. 

“It is an enormous task. Although Solvency II’s implementation is still some way off we are doing a lot of work now to make sure we are ready,” says Paul Appleton, Senior Manager of Lloyd’s Market Finance and the man leading the market’s Solvency II efforts.

Lloyd's Internal Model (LIM)
The focus of activity within the Corporation at Lloyd’s is to develop its own internal model for setting its capital under the new rules and to get it approved by the UK regulator. It is designing the Lloyd’s Internal Model (LIM), which closely reflects the day-to-day risks the market tackles, rather than relying on a standard formula. By doing this Lloyd’s expects its regulatory capital to be lower than if it used the off-the-shelf calculation. That’s because it will be able to show how its diverse business mix, made up of different lines of business and risks from many countries, reduces its exposure to big shocks such as a huge hurricane or stock market crash.

But in order to win approval from the watchdog for LIM not only does Lloyd’s need to meet the Solvency II standards, so must every managing agency. Syndicates already have their own models, which they use to set their capital, subject to review by Lloyd’s; but these models must be shown to be integral to how the business is run to meet the new standards, while Solvency II also imposes stringent new requirements on insurers’ processes.

 “It’s a major undertaking for both us and the managing agents,” Appleton says. “The key is to give the syndicates and managing agents as much support as possible. We are working with each managing agent in a ‘dry run’ process to help them get ready for Solvency II.  As part of this, we have given each agent a ‘Solvency II account manager’ who is effectively a dedicated contact for that agency to access the resources of the Corporation.” There are over 90 people within the Corporation working on making sure it is ready for the new solvency rules when they come into place.

Despite the enormous demands being placed on it by Solvency II, Lloyd’s is in good shape to meet the end-2012 deadline. “There’s a lot of work still to be done, but so far we think we’re doing well. We’re making good progress in developing LIM and redefining our risk management framework. We enjoy a good working relationship with the FSA. Also, we’ve seen a very significant engagement from the Lloyd’s market in getting ready for Solvency II,” Appleton says.

Lloyd’s is also working hard to ensure the final rules truly reflect the risk posed by insurers and that they are not caught up in the regulatory and political backlash from the recent financial crisis. “The insurance industry navigated the crisis well, on the whole. We are not the banking industry and we have a very different business model from the banks. Insurers’ core activities do not present a systemic risk to the global economy,” Alastair Evans, Head of Lloyd’s Government Policy and Affairs unit, tells lloyds.com.

“The majority of Lloyd’s business comes from outside the EU, so it’s very important for us to not be put at a disadvantage to those companies that will not be subject to this regulatory framework. We want it to be appropriate and to ensure the capital requirements are not excessively prudent,” Evans concludes.

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