Solvency Ⅱ And Its Implications For China

Insurance industry is a unique industry aiming at managing risk. The insurer has the right to receive premium at first place, however, the cost of the insurer will not occur nor become certain until the peril happens. Thus, the insured will suffer loss if the insurer cannot fully and duly discharge its insurance liability. As a result, regulation of the insurance industry is absolutely necessary. In the context of market economy and free competition, supervisory authorities worldwide place more importance of the supervision on the solvency of the insurer.Since the establishment of China Insurance Regulatory Commission (CIRC), the supervisory authority in china has attached great importance to the insurance supervision. It has proposed the "five lines of defense "and the "three pillars "as the building block of insurance regulatory system."Five lines of defense " can be summarized as:the company internal control as the basis; solvency supervision at core; monitoring the flow of capital as key:on-site inspection as an important tool; and the insurance guarantee fund as final protection. "Three pillars " of the regulatory framework means:market conduct regulation, solvency regulation and supervision of the corporate governance of insurance company. Thus, supervision of the solvency of insurer has always been a priority of the regulation.Supervision of the solvency of insurance industry in China borrowed a lot from the Western developed economies, especially the EU regulatory approach. The current EU regulatory framework focuses on the supervision of solvency margin. This regulatory approach is simple, and easy to conduct. It is wise for China to adopt this approach in the beginning of its insurance solvency supervision. However, there are also unacceptable deficiencies in the margin supervision. As a result, EU started its insurance solvency supervision revolution, namely Solvency II project. The project has absorbed the latest development in insurance solvency regulation and risk management worldwide. And the aim of the project is to establish an insurance regulatory framework that is fully risk-based and can strike a better balance between policyholder protection and the promotion of the competitiveness of EU insurers, promoting the convergence of regulatory practice in Member States and contributing to the establishment of an EU wide Single Market.In April 2009 the European Commission has adopted SolvencyⅡDirective. With the development of the implementation details, the Directive will come into force in 2012, ushering a new era of insurance regulation. This paper begins with introducing the historical development of the solvency supervision in EU. In the first chapter it describes the evolution of the solvency supervision as well as the current solvency requirement in EU and analyses the reason for the reform of the solvency supervision system.Solvency reform is a massive project that includes not only many complex issues of insurance regulation, but also the coordination of the supervisory authorities in Member States. The second chapter describes the characteristics of SolvencyⅡas well as main stakeholders of the project and its "three phase" development.In the end of this chapter, summarizes the type of insurance entities that subject to SolvencyⅡregulations.The content of SolvencyⅡDirective is the core of this paper. The third chapter systematically introduces the directive. The directive adopted three-pillar approach to construct the regulatory framework. The first pillar is the quantitative requirement which consists of five parts:the valuation of assets and liabilities, rules concerning technical provision, the requirement of own funds, capital requirements and investment rules. In the valuation of assets and liabilities, the Directive adopted the IFRS definition of fair value as the valuation basis, in order to avoid the unfair competition caused by the difference in the valuation principle in Member States. With respect to technical provision SolvencyⅡoverhauled the current "prudent" principle, replaced it with explicit risk margin. The valuation of Technical provision is the Current Exit Value model that is the amount the insurer would expect to pay at the reporting date to transfer its remaining contractual rights and obligations immediately to another entity. Own funds is of vital importance for the insurance entities to absorb loss. SolvencyⅡlearned from Basel Accord, adopted a three tier approach.In order to know the amount of eligible own funds, there are three steps to follow:first step:distinguish between basic own funds and ancillary own funds. Second step:define criteria used to classify own funds into tiers. Third step:put limits on the holding of second and third tier own funds to meet solvency capital requirement.The capital requirement of SolvencyⅡconsists of two parts:Solvency Capital Requirement(SCR) and Minimum Capital Requirement(MCR). SCR lies in the center of the capital requirement in SolvencyⅡ, the calculation of which uses the method of Value at Risk, and shall subject to a confidence level of 99.5% over a one-year period.In order to better reflect the risk profile of insurance entity, the directive allows insures to adopt internal model to calculate its SCR. The calculation of SCR should incorporate all risks the insurer would face in the following year and all risk mitigation methods it would adopt. MCR is the bottom line of the capital requirement, the breach of which will result in direct supervisory intervention.In the aspect of investment, SolvencyⅡadopts the "prudent person" rule and places no specific limits on the category and amount of investment. The second pillar is qualitative requirement. This pillar is implemented by Supervisory Review Process (SRP). The review mainly considers the following aspects:technical provision, solvency capital requirement, minimum capital requirement, investment rules, own funds, internal model and governance. In order to deal with the deficiency found in the review process, the supervisory authorities will urge insures adopt preventative and corrective measures to remedy the deficiency including impose a capital add-on. The third pillar is disclosure requirement, including public disclosure, supervisory disclosure and CEIOPS disclosure. The disclosure incorporates emergent disclosure as well as regular disclosure. The insurer shall immediately disclose its solvency situation when SCR or MCR is no longer complied with. It has been ten years since the launch of Solvency II project, the adoption of the Solvency II Directive is of vital importance to the insurance industry. However, the supervision of insurance industry is a complex task, due to historical, political and time limits, the new directive has its own limitations. The fourth chapter discusses this matter by referring to two aspects of the directive:the supervision of insurance group and the lessons to be learned in the financial crisis. In the matter of group supervision, this article mainly introduces the concept of group support regime, its benefits and analyses the reasons for which it has not been incorporated in the current solvencyⅡdirective. In the part of analyzing the implication of the financial crisis brought to the supervision of insurance industry, this article discusses the following aspects:the treatment of risk; quantitative limits; the capacity of loss absorbency of own funds; the reliability of internal model and the supervision of insurance group.In the last chapter this article specifies the lessons we can borrow from the construction of SolvencyⅡ. The discussions fall into eight parts:three pillar approach; risk based supervision; quantitative requirements; qualitative requirements; public disclosure; preventative view; group supervision and legislative process.The main innovations of this paper are the systematic introduction and analyzing of the SolvencyⅡproject and the suggestion made to the construction of solvency regulatory framework in China. The main deficiencies of this paper are the omission of the other important aspects of the solvency supervision and the suggestions made to China solvency regulation is merely scratching the surface.