Paris — Like a ship battening down its hatches in front of an approaching gale, European insurers are beginning to alter their IT spending in order to prepare for the storm known as Solvency II.

With the implementation phase of the European Union regulations on the horizon, insurers are assessing the risk management and compliance tools at their disposal, says Nicolas Michellod, a senior analyst at Boston-based Celent. Michellod says Celent research indicates the average amount of money spent on compliance as a part of overall new IT spend for European insurers has risen from 4% to 7% over the last year.

As a result, Celent believes Solvency II will force insurance companies to spend in order to demonstrate their ability to manage risk. “Compliance is one field where CIO will invest more money in the future,” he says

Michellod adds the looming deadline is not just altering the amount of spending, but the nature of it. While now a great preponderance of the investment for compliance is concentrated internally and on consultants, this is shifting. “The closer we get to the effective date, the more we will see spending on hardware and software,” he says.

Since Solvency II compels insurers to use risk-based mechanisms to calculate their capital requirements, carriers would be wise to avail themselves of sophisticated risk-management tools, Michellod says. “When it comes to advanced risk management tools, there are already very good tools on the market.”

Moreover, another business challenge for insurers who will operate under Solvency II is determining whether they will follow the standard model prescribed in the regulations, or construct their own internal model, Michellod says.

In a research report he authored in April, Michellod contended insurers might opt for the latter. “Celent believes that companies want to privilege the internal model approach for two reasons,” he wrote. “First, it is always easier to build on existing principles and processes instead of starting from scratch. Second, insurance companies tend to think that they are unique among their peers. Therefore, only dedicated risk management models can reflect their real particularities.”

Indeed, Michellod says insurers may come to view the stringent risk management requirements as a chance to gain competitive advantage, and that insurance technologists, in particular, should view the regulations as more of an opportunity than a threat.

“Compliance and regulation will push companies to give more responsibility to chief risk officers,” he says. “Considering that analytics is becoming more sophisticated, experts with deep knowledge in IT, insurance mathematics, and finance may emerge as the new leaders in the insurance industry.”

Solvency II also may alter the industry in other ways. The transparency requirements enshrined in Pillar III of the regulations may cause insurers to realign their IT architecture. The capital requirements of Pillar I may cause companies to seek greater diversification, which may, in turn, lead to more consolidation in the industry. Conversely, it also may force insurers to shy away from high severity risks because of the attendant capital requirements. “With Sol II, capital requirements reflect the true costs of risks,” Michellod says.

While Solvency II is aimed at insurers domiciled within member countries of the European Union, Michellod expects the reverberations of standards will have a global impact. “In the long run, we expect other countries to emulate what Europe is trying to achieve, just to maintain competitiveness.”

Sources: Celent, INN archives

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