The European Union has long been tightening the rules governing insurance companies in a bid to improve financial security across the market. After almost a decade of wrangling, consultation and protracted negotiations, the Solvency II directive framework was finally agreed in April this year.

However, the severe market crashes in 2008 have led to a crisis of confidence among savers, pushing regulators to conclude that there needs to be even higher levels of consumer protection. Consequently, as part of the level two negotiations that determine how Solvency II will be implemented, the Committee of European Insurance and Occupational Pensions Supervisors (CEIOPS) is pushing for more rigorous requirements on the capital eligible for insurers’ own funds and severe stress tests and parameters for calculating capital requirements.

Justifying a move to a more stringent directive, CEIOPS states: “Experience has taught [us] that in real crisis situations, only high quality capital elements can truly be a first line of defence in the sense of absorbing losses without taking the insurer into full bankruptcy.”

The proposals have caused widespread consternation among all European insurers, but it is the Scandinavian markets that have exhibited the greatest levels of anxiety, where companies and industry bodies feel the regulators are going too far.

Ellen Bramness Arvidsson, chief economist at the Swedish Insurance Federation, says: “In the Swedish market, we have followed CEIOPS’s advice on level two regulation with growing concern. Our greatest fear is that, in reality, CEIOPS is reopening the political debate on capital levels.”

Ms Bramness Arvidsson’s disquiet is reflected at the Danish Insurance Association, where executive director Peter Skjødt says he has moved from a position of broad support for the Solvency II directive to one of alarm at where the regulations are heading.

“We have been among the most vocal supporters of the solvency regulations and we already have a risk-based regulatory regime in place, but the latest developments are of great concern,” Mr Skjødt says.

A common complaint from insurance companies, and not just from those in the Nordic region, is that in spite of emerging from the financial crisis relatively unscathed, the sector is being penalised for mistakes made elsewhere in the financial industry.

Nick Readings, director at Scandinavian Capital Solutions, says: “[The insurers] weren’t the ones who messed up, yet we are the ones who end up getting hit with tighter regulation.”

European insurers also argue that the proposals for more stringent capital requirements will result in additional costs, which are inevitably passed to the end consumer, thereby threatening the industry’s competitiveness.

Further, Ms Bramness Arvidsson adds that the proposed increase in prudence jeopardises the accuracy when measuring individual risks and clouds the analysis of value at risk as a whole.

“This could weaken companies’ incentives for good risk control, [which] is an impediment for the development of reasonably priced, good consumer protection,” she says.

Additionally, the internal costs of meeting CEIOPS’s requirements may force some smaller insurers to drop out of the market, which limits consumer choice and may further damage confidence in the market, ultimately undermining the overall objective of the Solvency II directive.

Mr Skjødt says: “The governance and reporting requirements are extremely detailed and complex, so for an [insurance] company with 20 or 30 employees it is a huge cost. In the beginning, we said Solvency II could benefit smaller companies, but now we believe they may not be able to survive.”

More specific concerns for the insurers in the Nordic region centre on proposals to set a risk-free rate to discount liabilities (see box on page 31). CEIOPS states that the financial crisis underlined the relevance of holding ample amounts of high-grade capital, adding: “Solvency II should ensure a sufficient quality of capital that guarantees its loss absorbing capacity, in particular under stressed conditions.”

In consultation paper 40 (CP40), the regulator proposes that insurers discount their liabilities at a risk-free rate to ensure they have sufficient capital to meet their obligations in the event the company runs into trouble. CEIOPS’s favoured instrument is AAA-rated government bonds, but this has met with numerous objections from Scandinavian insurers who believe the proposal leaves them at an unfair disadvantage. In particular, the scarcity of long-dated AAA-rated bonds in the Nordic region poses a real problem for insurers writing occupational pensions business that stretches out to 60 or 70 years.

Henrik Olejasz Larsen, chief investment officer at Danish pension company Sampension, says: “The consultation paper says [liabilities] should be [discounted at] risk-free government rates from the outset. My Swedish and Norwegian colleagues are hesitant and scared about this, because there are no long-term government bonds in Norway and hardly any in Sweden. Although we have slightly more in Denmark, their availability bears no relation to the amount we need for hedging activities.”

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