Just when insurance companies were feeling better equipped to solve the puzzle of requirements presented in the Sarbanes-Oxley Act (SOX), the United Kingdom and the 24 other member states in the European Union (EU) are now commenting on the EU Commission's proposed regulations on solvency that could be finalized as early as 2008. Called the Solvency II proposal, the regulations are not unlike the Sarbanes-Oxley Act, and could add more layers of regulatory reporting for insurers.American carriers and reinsurers need to get up to speed on Solvency II, say analysts, because down the road, the regulations could impact U.S. accounting and insurance standards.

Will U.S. regulators, now providing some input into the process, look at the EU's solution to preventing insolvencies with an eye to copying some of it in the states? Will the federal government see it as a prototype for some oversight of the industry in future years? No one knows, but a general knowledge of Solvency II is needed to avoid the surprise factor in any scenario.

In addition to U.S. companies doing business in Europe, some stakeholders in this game include the Committee of European Insurance and Occupational Pensions Supervisors (CEIOPS), the EU leaders, the International Accounting Standards Board (IASB), the International Association of Insurance Supervisors (IAIS), and the Organization for Economic Cooperation and Development (OECD). In the end, Parliament and the Council of the European Union will hear all of the recommendations, amend or leave the proposal as it is, and, eventually adopt a "directive" or law that will apply to all 25 member states in the EU.

At press time, Solvency II incorporated elements of risk-based capital, and permitted insurers to use their own internal models in setting capital requirements. The new regulation will also require a much broader scope of company information. The exact formulas for all of these requirements were still under debate. But observers were speculating about what technologies may be required.

Systems for compliance

"Many major U.S. property/casualty and life and health insurers already have seen the handwriting on the wall and have installed software products that capture critical information needed to comply with Solvency II, " says Andrew Whalen, vice president, insurance and healthcare division of Infogix Inc., (formerly Unitech Systems Inc.), Naperville, Ill.

"The larger companies see the critical need to install comprehensive software programs, including automated information controls that ensure accurate, consistent and reliable information gleaned from the entire company. This information then must be updated so it is always completely correct," Whalen says.

Whalen points out that capturing financial information about a company's reserves and investments may be critical to assessing the risk of insolvency, but information about what the company knows about its risks and the control points within a company are also key components in the assessment of a company's potential to become insolvent.

A U.K. government report on Solvency II concurs with Whalen's assessment of the type of data needed. The report, titled "Prudential Supervision of Insurance Undertakings," concludes that insolvent companies experienced a chain of multiple causes for insolvencies, including underlying internal problems that led to inadequate internal controls and decision-making processes that resulted in inappropriate risk decisions.

Questions remain

Even with these conclusions, the question remains whether smaller or medium-sized companies will be able to afford the technologies required to establish adequate internal controls. Affordable or not, sources agree that transparency will be a key factor under Solvency II, and companies will need sophisticated IT systems to provide it.

"New financial reporting requirements such as those being considered in Sarbanes-Oxley or Solvency II will escalate the need for consistent and quality data that will facilitate transparency," says Beth Grossman, assistant vice president for ACORD, Pearl River, N.Y.

"It is clear there is a need to integrate operational, transactional and financial data in order to comply confidently with the need for transparency. Only agreed-upon industry standards implemented throughout the value chain can address this challenge," she says.

Earlier this year, SunGard Sherwood Systems, a UK-based technology provider with offices in Armonk, N.Y. and Ontario, Canada, warned European insurance CEOs that they must be able to provide the level of information now required by regulatory authorities, and they'll have to improve their data transparency and provide more detailed information to supervisors in the future. For many European insurers, this will be a radical change from the current reporting practices, according to SunGard which claimed that putting technologies in place to comply with Solvency II could take as long as two to three years for some companies.

What about U.S. insurers? Are they aware of Solvency II? Some companies doing business in Europe are-and U.S. insurance regulators have provided input to their European counterparts.

The National Association of Insurance Commissioners (NAIC), Kansas City, Mo., for example, is keeping a high-level, watchful eye on the EU as it moves toward finalizing Solvency II, but the organization declined to comment on the direction, approval or non-approval of what has been proposed.

The Property Casualty Insurers Association of America (PCI), Des Plaines, Ill., indicated it is following Solvency II's development, but is not actively providing input in the process.

European trade groups, however, have added their two cents. Accountants in Europe have warned EU supervisors against using provisions in Solvency II that are similar to the U.S. Sarbanes-Oxley Act on risk management and internal controls.

A report issued earlier this year by FEE, the organization that represents the European accounting profession, states "some member states (countries) will have implementation challenges that will take time to resolve if requirements mirror what is proposed in Sarbanes-Oxley."

At this time, reinsurers on both continents are not included under the umbrella of the proposed regulation. But a new reinsurance directive in Europe is in the final stages of adoption, and will likely place reinsurers under the provisions of Solvency II.

Overview of Solvency II

The EU began its fundamental review of solvency in May 2001. The Commission looked at the effectiveness of the current European solvency system, how the current supervisors could prevent, detect and cure problems, and what the typical insolvency warning signals were. The result of the review supported the need to create a regulation that would tackle the "full causal chain," and to have supervisory tools to focus on company management and how they manage risk.

"The Solvency II system is based on the European Basel three-pillar banking model," says Morag Fullilove, principal for Fullilove Consulting Group, Chicago and Brussels, Belgium.

"Pillar I examines what the capital requirements are. Pillar II looks at supervisory activities and company management and Pillar III addresses reporting and public disclosure," says Fullilove. "In addition, it has been made clear already that valuation rules, supervisory reporting, and public disclosure under Solvency II should be based on the public accounting rules of the International Accounting Standards Board (IASB), which are in use in Europe, rather than a separate statutory system as in the U.S."

Fullilove adds that on the flip side, the EU has indicated that Solvency II should not contain too many proscriptive regulations, that it should avoid inordinate complications and it should reflect market developments. But Solvency II will probably require disclosure of internal governance provisions, risk models, scenario testing, and other internal procedures as well as financial and investment information.

Susan McKenna is a business writer based in Chicago.

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