Planned Solvency III Regulation: Should It Be Adopted Outside the European Union?

Peter Zweifel

doi:10.1515/apjri-2018-0002

Article

Planned Solvency III Regulation: Should It Be Adopted Outside the European Union?

Peter Zweifel

Published/Copyright: January 31, 2019

Published by

Become an author with De Gruyter Brill

Submit Manuscript Author Information Explore this Subject

From the journal Asia-Pacific Journal of Risk and Insurance Volume 13 Issue 1

Abstract

Several countries outside the European Union consider adopting its solvency regulation for their insurance industries. However, Solvency I and (to a lesser extent) Solvency II were found to run the risk of inducing more rather than less risk-taking by insurers (Zweifel, Peter. 2014. “Solvency Regulation of Insurers: A Regulatory Failure?” Journal of Insurance Issues 37 (2): 135–157.). Companies are led to neglect parameters that link them to developments in the capital market when determining their endogenous perceived efficiency frontier (EPEF), causing it to become steeper. Given homothetic risk preferences, senior management is predicted to opt for increased rather than reduced volatility. By way of contrast, if modeled after Basel III for banks, planned Solvency III will ask insurers to take developments in the capital market into account in their formulation of business strategies designed to ensure solvency (Principle 5 of Basel III). In addition, the stipulated decrease in their leverage ratio is shown to reduce the slope of the EPEF for insurers with little solvency capital. Contrary to its predecessors, Solvency III is therefore predicted to make insurers take on less risk, which argues for its for adoption beyond the European Union if properly implemented.

Keywords: regulation; insurers; solvency; Solvency I; Solvency II; Solvency III; Basel III

JEL Classification: G15; G21; G28; L51

A Appendix

Table 1:

Assumptions of the model.

A1:	μ=μˉ+μˆ;σ=σˉ+σˆ	Returns and volatility (μ,σ) are additive in an exogenous (μˉ,σˉ) component determined on the capital market and an endogenous one.
A2:	∂C/∂μˉ<0	The higher returns on the capital market, the less risk capital is needed to attain a given solvency level. A positive shock on returns makes positive net values of the company more likely, therefore reducing the need for risk capital.
A3:	∂C/∂σˉ>0	The higher volatility on the capital market, the more risk capital is needed to attain a given solvency level. Positive net values of the insurer are less likely, and this must be counteracted by more risk capital.
A4:	∂P∂μˉ<0	The (present value of) premium income depends negatively on the rate of return attainable on the capital market because policyholders now have more favorable investment alternatives.
A5:	∂P∂σˉ>0	The (present value of) premium income depends positively on the volatility of returns on the capital market because the insurer now offers a comparatively safe investment alternative to risk-averse policyholders.
A6:	∂2C∂S∂μˉ<0	A higher solvency level calls for more risk capital but to a lesser degree if higher market returns prevail, making positive net values of the company more likely.
A7:	∂2C∂S∂σˉ>0	A higher solvency level calls for more risk capital, especially when market volatility is high, making positive net values of the company less likely.
A8:	∂2P∂S∂μˉ>0	While a higher rate of return on the capital market depresses premium income (see A4), this effect weakens if the insurer offers a high level of solvency,
A9:	∂2P∂S∂σˉ>0	Higher volatility on the capital market serves to increase premium income (see A5); this effect is reinforced if the solvency levels is high.

B Appendix

First, consider a shock dμˉ disturbing the first-order condition (4). The comparative static equation reads,

(11)∂2R∂S2dS∗+∂2R∂S∂μˉdμˉ=0.

Since ∂2R/∂S2<0 in the neighborhood of a maximum, sgn∂2R/∂S∂μˉ determines

sgndS∗/dμˉ. Differentiating eq. (4) w.r.t.μˉ, one has

(12)∂2R∂S∂μˉ=∂e(P,S)∂μˉ−∂∂μˉe(C,S)(1−L/P)=∂∂μˉ∂P∂S⋅SP−∂∂μˉ∂C∂S⋅SC(1−L/P)=S∂2P∂S∂μˉ(+)⋅1P−∂P∂S(+)∂P/∂μˉP2−∂2C∂S∂μˉ⋅1C+∂C∂S(+)∂C/∂μˉC2(1−L/P)+∂C∂SL⋅∂P/∂μˉC⋅P2(+)(+)

The signs are based on assumptions A9, A4, and A2 as well as eqs. (1) and (2). This is expression (5) of the text.

Now consider dσˉ>0. In full analogy to (11), one obtains from eq. (4),

(13)∂2R∂S∂σˉ=∂e(P,S)∂σˉ−∂∂σˉe(C,S)(1−L/P) =∂∂σˉ∂P∂S⋅SP−∂∂σˉ∂C∂S⋅SC(1−L/P)=S∂2P∂S∂σˉ(+)⋅1P−∂P∂S(+)∂P/∂σˉP2(+)−∂2C∂S∂σˉ(+)⋅1C+∂C∂S(+)∂C/∂σˉC2(+)(1−L/P)+∂C∂S(+)L⋅∂P/∂σˉC⋅P2(+)

The signs are based on assumptions A9, A5, and A3 of Table 1 as well as eqs. (1) and (2) of the text. This is expression (6) of the text.

Acknowledgements

The author would like to thank participants in the Finance and Banking Seminar of the University of Zurich as well as the 44th Seminar of the European Group of Risk and Insurance Economists (London, 2017) and especially Ray Rees (University of Munich) for comments and criticism. The usual disclaimer applies.

References

Actuarial Post. 2018. “Insurers Face Solvency II Cost Estimated to Exceed £200 M.” http://www.actuarialpost.co.uk/article/insurers-face-solvency-ii-costs-estimated-to-exceed-%C2%A3200m-1158.htmSearch in Google Scholar

Basel Committee on Banking Supervision. 1988. International Convergence of Capital Measurement and Capital Standards. Basel: Bank for International Settlements.Search in Google Scholar

Basel Committee on Banking Supervision. 2004. Basel II: international Convergence of Capital Measurement and Capital Standards: a Revised Framework. Basel: Bank for International Settlements.Search in Google Scholar

Basel Committee on Banking Supervision. 2011. Basel III: A Global Regulatory Framework for More Resilient Insurers and Banking Systems – revised Version June 2011. Basel: Bank for International Settlements.Search in Google Scholar

Basel Committee on Banking Supervision. 2016. Interest Rate Risk in the Banking Book. Basel: Bank for International Settlements.Search in Google Scholar

Bauer, Wolfgang, and Mark Ryser. 2004. “Risk Management Strategies for Insurers.” Journal of Banking & Finance 28: 331–352.10.1016/S0378-4266(03)00193-6Search in Google Scholar

Benink, Harald, and George Benston. 2005. “The Future of Banking Regulation in Developed Countries: Lessons from and for Europe.” Financial Markets, Institutions & Instruments 14 (5): 290–328.10.1111/j.0963-8008.2005.00109.xSearch in Google Scholar

Boulès, Renaud, and Dominique Henriet. 2009. “Capital Reserve Policy, Regulation and Credibility in Insurance. GREQAM Aix-Marseille.” Working Paper. 2009–2016.Search in Google Scholar

Cummins, David, J. 1988. Risk-based premiums for insurance guaranty funds. Journal of Finance 63(4), 823–839.10.1111/j.1540-6261.1988.tb02607.xSearch in Google Scholar

Cummins, David, J., and Richard D. Phillips. 2001. “Applications of Financial Pricing Models in Property-Liability Insurance.” In Handbook of Insurance, edited by G. Dionne, 621–655. Dordrecht: Springer.10.1007/978-94-010-0642-2_19Search in Google Scholar

Cummins, David, J., and David W. Sommer. 1996. “Capital-Risk in Property-Liability Insurance Markets.” Journal of Banking and Finance 20: 1069–1092.10.1016/0378-4266(95)00044-5Search in Google Scholar

Epermanis, Karen, and Scott E. Harrington. 2006. “Market Discipline in Property/Casualty Insurance: Evidence from Premium Growth Surrounding Changes in Financial Strength Ratings.” Journal of Money Credit and Banking 38 (6): 1515–1544.10.1353/mcb.2006.0081Search in Google Scholar

Furfine, Craig H. 2003. “Interinsurer Exposures: Quantifying the Risk of Contagion.” Journal of Money, Credit, and Banking 35: 111–128.10.1353/mcb.2003.0004Search in Google Scholar

Goldberg, Lawrence G., and Sylvia C. Hudgins. 1996. “Response of Uninsured Depositors to Impending S&L Failures: Evidence of Depositor Discipline.” Quarterly Review of Economics and Finance 36: 311–325.10.1016/S1062-9769(96)90018-6Search in Google Scholar

Goldberg, Lawrence G., and Sylvia C. Hudgins. 2002. “Depositor Discipline and Changing Strategies for Regulating Thrift Institutions.” Journal of Financial Economics 63: 263–274.10.1016/S0304-405X(01)00096-4Search in Google Scholar

Gomley, Todd A., and David A. Matsa. 2016. “Playing It Safe? Managerial Preferences, Risk, and Agency Conflicts.” Journal of Financial Economics 122 (3): 431–455.10.1016/j.jfineco.2016.08.002Search in Google Scholar

infosys. 2017. “Solvency II Compliance Improves Risk Management and Reduces Total Cost of Ownership (TCO).” https://www.infosys.com/industries/insurance/case-studies/Documents/solvency-II-compliance.pdf.Search in Google Scholar

Institute and Faculty of Actuaries. 2016. “Solvency II – General Insurance.” www.actuaries.org.uk/documents/solvency-ii-general-insurance.Search in Google Scholar

IQ insurer quarterly. 2011. “Solvency III: The Next Episode?” www.insurerquarterly.com/solvency-iii-the-next-episode, accessed 14 Jan 2018.Search in Google Scholar

Jordan, John S. 2000. “Depositor Discipline at Failing Insurers.” New England Economic Review. March/ April,15–28.Search in Google Scholar

Laas, Daniela, and Caroline Siegel. 2017. “Basel III versus Solvency II: An Analysis of Regulatory Consistency under the New Capital Standards.” Journal of Risk and Insurance 84 (4): 1231–1267.10.1111/jori.12154Search in Google Scholar

Liu, Min. 2015. “A New Insurance Regulation Regime for China.” http://www.air-worldwide.com/Blog/A-New-Insurance-Regulation-Regime-for-China/.Search in Google Scholar

Milidonis, Andreas, and Konstantinos Stathopoulos. 2014. “Managerial Incentives, Risk Aversion, and Debt.” Journal of Financial and Quantitative Analysis 49 (2): 453–481.10.1017/S0022109014000301Search in Google Scholar

Moody’s Investor Service. 2011. “Sovereign Defaults and Recoveries, 1983–2010, 10 May.” http://efinance.org.cn/cn/FEben/Sovereign%20Default%20and%20recovery%20rates,1983-2010.pdf.Search in Google Scholar

Nakada, Peter, Hemant Shah, H. Ugur Koyluogo, and Olivier Collignon. 1999. “P&C RAROC: A Catalyst for Improved Capital Management in the Property and Casualty Insurance Industry.” Journal of Risk Finance 1 (1): 52–69.10.1108/eb022937Search in Google Scholar

Ng, Questor, and Raymond Cheung, Ca. 2015. “Development of Risk Based Capital Framework in Singapore.” http://actuaries.org/FUND/singapore/IndustryUpdateRBCDevelop_Cheung.pdf.Search in Google Scholar

O`Shea, Mairead. 2013. Comparison of the Regulatory Approach in Insurance and Banking in the Context of Solvency II. Brussels: European Actuarial Consultative Group.Search in Google Scholar

Park, Sangkyun, and Stavros Peristiani. 1998. “Market Discipline by Thrift Depositors.” Journal of Money, Credit, and Banking 30: 347–364.10.2307/2601105Search in Google Scholar

Power, Michael. 2004. The Risk Management of Everything. Rethinking the Politics of Uncertainty. London: Demos.Search in Google Scholar

Rees, Ray, Hugh Gravelle, and Achim Wambach. 1999. “Regulation of Insurance Markets.” Geneva Papers on Risk and Insurance Theory 24: 55–63.10.1023/A:1008733315931Search in Google Scholar

relbanks.com. 2017. “Top UK Insurance Companies.” www.relbanks.com/top-insurance-companies/uk.Search in Google Scholar

Repullo, Rafael. 2004. “Capital Requirements, Market Power, and Risk-Taking in Banking.” Journal of Financial Intermediation 13: 156–182.10.1016/j.jfi.2003.08.005Search in Google Scholar

Stulz, René M. 1996. “Rethinking Risk Management.” Journal of Applied Corporate Finance 9: 8–24.10.1111/j.1745-6622.1996.tb00295.xSearch in Google Scholar

Sukpaiboonwat, Sivalap, Chucheep Piputsitel, and Arunee Punyasavatsut. 2014. “Thailand Insurance Regulation: Highlights and Time to Move Ahead.” Asian Social Science 10 (6).10.5539/ass.v10n6p24Search in Google Scholar

SwissRe. 2015. “Insurance Solvency in Latin America.” http://www.swissre.com/latin_america/insurance_solvency_regulation_latam.html.Search in Google Scholar

Van Hulle, Karel, ca. 2016. “From Solvency II to Solvency III? ICIR Publications.” http://www.icir.de/fileadmin/Documents/Policy_Platform/4_VanHulle.pdf.Search in Google Scholar

World Finance. 2010. “Basel II to Solvency II.” http://www.worldfinance.com/home/risk-encyclopedia/baselII-to-solcencyII.Search in Google Scholar

Zweifel, Peter. 2014. “Solvency Regulation of Insurers: A Regulatory Failure?” Journal of Insurance Issues 37 (2): 135–157.Search in Google Scholar

Zweifel, Peter. 2015. “Solvency Regulation of Banks and Insurers: A Two-Pronged Critique.” International Journal of Financial Research 6 (3): 86–105.10.5430/ijfr.v6n3p86Search in Google Scholar

Zweifel, Peter, and Roland Eisen. 2012. Insurance Economics. Berlin: Springer.10.1007/978-3-642-20548-4Search in Google Scholar

Published Online: 2019-01-31

You are currently not able to access this content.

Articles in the same Issue

https://doi.org/10.1515/apjri-2018-0002

Keywords for this article

regulation; insurers; solvency; Solvency I; Solvency II; Solvency III; Basel III