Developing New Risk-Based Capital Standards Across Europe

Insurance supervision in the European Union is undergoing significant changes as the European Commission works toward harmonization across member countries as well as toward the implementation of standards that are appropriate for a rapidly changing marketplace. Current efforts are focused on Solvency II regulations, which aim at being the foundation of EU insurance regulation in the 21st century. Solvency II will require an enterprise risk management approach and risk-based calculations of the required minimum equity capital. So as not to suffer any competitive disadvan-tage, the Swiss Federal Office of Private Insurance recently introduced the Swiss Solvency Test, a system very comparable to the Solvency II regulations.

However, outlining the details of Solvency II and the Swiss Solvency Test, we find that there is no research using European data that investigates the pros and cons of different regulatory systems. Thus, there is an urgent need for work on the success, or lack thereof, of different solvency models in measuring financial distress. Existing evidence suggests that the risk-based capital standards introduced in the United States in 1994 are not very successful. The model recently introduced by the German Insurance Association, the new Swiss model, and the models currently employed in the United Kingdom and the Netherlands may be better systems, but we cannot state which is best until the research is undertaken. Furthermore, research on the influence of market factors, such as rating agencies, should be considered as U.S. experience suggests that rating agencies have been more successful in identifying financial dis-tress than has the regulatory framework. In addition, no one has yet analyzed the economic effects of the planned solvency regulations e.g. on European capital mar-kets. Hence there is a great need for further research.

We intend to do that research. Our goal is to give practical aid to the decisionmakers responsible for formulating an effective set of regulations and to encourage additional research on best practices for successful capital standards.