Countdown to Solvency II

Solvency II presents an opportunity for the accounting profession to play a key role in the development of a robust and reliable regulatory framework for insurance companies, writes Tim O’Hanrahan and Sylvia Cronin.

Insurance regulation in the European Union is facing its most significant overhaul in over 40 years. The new regime, Solvency II, will have a significant impact on insurance companies and as accountants play a pivotal role in insurance, both working in insurance companies and providing professional services to insurance companies, it is important to discuss one of the key changes that will impact on the accountancy profession – enhanced reporting.

Before we look at the detail, it is important to reflect on why Solvency II is being introduced. The current Solvency I regime has been in place since the 1970s and consists of 14 separate European Directives. While there have been modifications to the regime, there was growing concern that Solvency I did not reflect the increasingly complicated risks facing the modern insurance industry and therefore required a significant overhaul. This led to the introduction of Solvency II, which has an implementation date of 1st January 2016.

The Solvency II regime is based on a three pillar approach. Pillar one addresses quantitative requirements, which will fundamentally alter how technical reserves and capital are calculated for insurance companies. Pillar two addresses qualitative requirements, which include governance. Pillar three, meanwhile, addresses reporting and disclosure.Solvency II will increase the quantity and quality of reporting submitted by insurance companies to regulators and enhances the level of disclosure insurance companies must make to the market.

Enhanced regulatory reporting

A notable limitation of the Solvency I regime was the absence of detailed prescribed regulatory returns. Over time, the existing returns became less relevant to both insurance companies and their regulators.

The Solvency II regime, however, significantly enhances the quantity and quality of reporting that insurance companies will need to submit to regulatory authorities. These new regulatory returns are poised to become a central tool in regulators’ efforts to understand Irish insurance companies and challenge their management in a constructive manner.

Accountants should play a key role in the preparation and review of regulatory returns. As such, they will play a central role in the success of the new reporting regime.

From 1st January 2016, reporting requirements will include:

• Day one (once-off) reporting of quantitative regulatory returns and narrative reporting;
• Regular report to supervisors including quarterly quantitative regulatory returns and annual quantitative regulatory returns and narrative reporting;
• Annual public reporting of the Solvency and Financial Condition Report, which includes both quantitative and narrative reports; and
• Own risk and solvency assessment (ORSA).

The European Insurance and Occupational Pensions Authority (EIOPA) guidelines require ORSAs to be performed annually, and insurance companies are required to inform the supervisory authorities of the results of each ORSA. Table 1 (overleaf) illustrates the extent and frequency of Solvency II day one reports, quarterly reports and annual returns.

Challenges ahead

With new reporting comes new challenges. These include:

• Volume of forms: insurers must submit quarterly and annual regulatory returns within tight timelines. Irish insurers will have to submit up to 93 separate forms on an annual basis – 80 EIOPA templates, 11 national specific templates and two statistical templates.
• A dearth of data: Solvency II requires insurance companies to submit data that may not be currently captured in reporting systems. For example, companies are required to list each individual security held as part of their investments. The forms require multiple data fields including International Securities Identification Number (ISIN) codes.
• Data submission formats: the Central Bank of Ireland will only accept data in eXtensible Business Reporting Language (XBRL) format, which efficiently checks, handles and facilitates the transmission of large data volumes. Many firms do not have this capability and will have to develop or acquire it, or engage the services of a third-party supplier.
• The valuation basis: Solvency II valuation rules differ from International Financial Reporting Standards, Irish Generally Accepted Accounting Practice and Internal Management Accounts. Companies will need IT systems that can produce regulatory returns in accordance with the valuation requirements of Solvency II.
• Internal governance: firms will need to ensure that internal governance procedures are appropriate and their IT tools are sufficiently robust to report accurate data to regulators. The Solvency II Directive requires companies to have appropriate systems and structures in place to fulfil the reporting requirements as well as a written policy, approved by the board, ensuring the ongoing appropriateness of the information submitted. The Solvency II Directive also requires that the board approve the Solvency and Financial Condition Report.

Preparatory tasks

• Assessing and addressing data gaps;
• Reconciliations between regulatory returns, management accounts and financial statements and understanding any differences;
• Lessons learned from preparatory phase reporting to the Central Bank;
• Feedback from using the test phase of the Central Bank’s reporting environment;
• Challenges using XBRL including complexity and ensuring the company has the most up-to-date taxonomy from EIOPA’s website; and
• Completing dry runs of full Solvency II submission including internal governance reviews and sign-off by senior management and boards.

Central Bank engagement

Auditing of returns

Conclusion