Solvency II is a policy law established to serve 28 EU member states. The legislative program is to harmonize the vast EU-insurance regulatory regime. The key objectives of developing the solvency II were to: uplift consumer protection, modernization of supervision, deepening of the EU market integration and increment in the international competitiveness of the EU insurers. The solvency II has three main pillars namely pillar 1 (financial requirements), pillar 2 (governance and supervision) and pillar 3 (reporting and disclosures). This article is going to discuss majorly on pillar 1 of the solvency II. The building blocks of the financial requirements of pillar 1 are going to be identified and analyzed. The article will go ahead to discuss the role played by the solvency II of the insurance company by its supervision.
The building blocks of pillar 1 are: economic balance sheet, the results of the actual own funds and the required risk-based own funds. The capital requirements of the pillar are the solvency capital requirement and the minimum capital requirement. The economic balance sheet focuses on market valuation as its basic point of start. The pillar 1 solvency position of a company is evaluated by use of a standard formula provided by the European insurance and occupational authority. The market valuation is not straightforward but rather seeks to achieve insurance regulation via model building. Economic balance sheet is a big consideration in valuation of technical provisions. The solvency framework establishes a technical provisions that is going to cover for the expected future claims from the policymakers. The basis of SCR is the value at risk measure, which is evaluated as 99.5% confidence level over a period of one year. The probability of 99.5% reduces chances of an insurance company falling into solvency to a chance less than one in every 200 cases. The formula used in evaluating SCR utilizes the modular approach implying that any individual exposure to risk is first assessed and then a final aggregate is done collectively. The SCR is going to help in assessing its supervision by covering all the risks that an insurer is facing and will make sure that any mitigation risk is evaluated by the insurer.
Minimum capital requirement is the level that is considered minimum of the security below which the financial resources are not to fall. In case the minimum required funds falls below the MCR then the procedure that should be done is to withdraw the authorization of the insurance and reinsurance undertakings. The role played by the MCR is that it indicate the eligible point below which it will call the attention of the supervisor to make an intervention. The purpose of the MCR is to account for 85% probability of adequacy. The period that covers for adequacy probability is one year and always between 25% and 45% of the SCR. On a supervisory position the SCR is considered to be soft floors while the MCR is considered to be a hard floor. The SCR is considered soft since at this point it calls only for the attention of the supervisor without much consequences. The consequences of breaching MCR is that the regional supervisor is given the mandate by the solvency II directive to withdraw authorization from selling of new businesses and even winding up of the insurance company.
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