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The impact of Solvency II on data governance

Solvency II is coming to the €8.4 trillion insurance industry in Europe, and even the largest companies are feeling the heat. The reforms are a complete overhaul of previous data governance standards, and so far, its impact has been felt worldwide across the insurance sector. For example, Aegon, the UK insurance giant with operations in the Netherlands and the U.S. with Transamerica, saw its shares plunge by 23 percent in August. Aegon officials also announced that its capital surplus was set to be lower than previously expected in anticipation of the Solvency II regulations.

The warnings have many investors, insurers and regulators in European insurance companies wondering how Solvency II will impact them when it kicks in Jan. 1, 2016. However, despite the fact that this is currently an European Union regulation, the global operations of European insurers will be impacted by Solvency II, particularly those companies in North America.

“Many investors, insurers and regulators in European insurance companies wondering how Solvency II will impact them.”

Understanding Solvency II reforms on disclosure and data governance
These new Solvency II reforms were designed to standardize regulations on data governance and disclosure across all EU countries, rather than maintaining the piecemeal approach currently in place. The framework of Solvency II was also imposed to provide more authority to EU national authorities. In turn, the objective of the reforms is to improve protection for policyholders by bolstering insurers’ resilience against shocks or financial market crises.

Further, another main point of Solvency II is to provide regulators with accurate information so they can adequately analyze all the risks involved in an insurance company’s balance sheet. This process will be made easier under a unified data governance approach because regulators will be able to more effectively estimate a company’s potential liabilities and values of financial assets.

The impact of Solvency II on market values and capital resources
Solvency II will ensure that companies have stricter data protection measures in place so they can meet claims. Under the new regime, insurance companies are required to develop internal models to prove that they have implemented stronger data governance measures. In order to build these models, insurance companies need to have high-level data governance because they will need to know exactly where to find necessary data and understand how it has been managed. This is a particularly arduous process because although most insurers have been storing data for decades, they will need to build an entirely new data management team or use an externally managed data service.

Further complicating the Solvency II compliance process is the fact that these internal models will then need to be approved by regulators, which has resulted in countless hours and resources spent by companies in reviewing their databases for obscure information about their risk exposures. However, this process becomes more complicated if an insurer’s data governance model is not approved, because it will be forced to implement a standard formula given to them by regulators. As a result, this may cause companies to need to have more capital on hand to implement the model, after spending resources to develop the previous model that was not approved. According to a Financial Times interview with Jim Bichard, partner at PriceWaterhouse Coopers, this has led to a tremendous drain on resources.

“Whatever happens, Solvency II has been and continues to be a huge distraction,” Bichard explained. “Regardless of the outcome, people have expended a huge amount of resources, effort and time on this.”

All told, this has caused some insurers to begin losing market value.

Solvency II is a huge distraction to insurers.

The industry is panicking over losses
Insurance executives across Europe are wringing their hands with the pressures their companies are facing in last minute requirements. According to a Financial Times interview with Gordon Aitken, analyst at RBC Capital, share prices throughout the EU insurance sector are suffering as a result.

“We see risk skewed to the downside from Solvency II,” Aitken explained. “Even in the best-case scenario of a benign result, we do not expect share prices to react positively.”

Despite the fact that insurance executives have almost universally supported Solvency II, there are growing concerns about how it will work upon implementation. Among these concerns are the potential bureaucratic red tape due to new disclosure requirements. Under Solvency II, insurers now need to provide several times more information to regulators. However, perhaps more importantly, insurers fear that their businesses in foreign markets – especially the U.S. – will be put at a competitive disadvantage due to the resources spent on Solvency II compliance management.

Using Aegon as an example again, its executives have reported serious reservations about the risks of Solvency II. The insurance giant, which initially estimated its capital surplus under Solvency II to be between 50 percent and 100 percent above the minimum, has recently reported that that number had dropped to between 40-70 percent. This has caused concerns among its investors that the company will need to request more capital from shareholders.

What is clear is that investors are getting nervous about low ratios, particularly since most companies look for capital surpluses at a minimum of 60 percent. But the result of reduced leeway under Solvency II means that regulators will scrutinize the business models of many insurance companies, which could potentially lead to more constraints on business expansion and dividend payouts for investors.

Compounding these fears that are driving down market value across the board for insurance companies is the fact that talks between insurers and regulators have been kept behind closed doors. So investors have no real way of knowing which EU insurance companies will have their internal models approved by regulators.

The bottom line for insurance companies worldwide
According to a recent Ernst & Young report, while the initial effects leading up to Solvency II have been widespread throughout the EU, it is important to note that the impact will eventually be felt across the globe. Particularly as external disclosure of economic capital and risk-adjusted performance is on the horizon for U.S. companies as well. The reality is that all global insurance companies, particularly those in the U.S., will be required to improve financial risk disclosure in the near future.

Another harsh reality of Solvency II is that it has the potential to impact the geographic flow of capital due to changes in the competitive landscape. Solvency II could have implications on competitiveness of domestic U.S. insurance companies as several large EU insurers like Aegon own corporations in North America, which could lower the market value of those companies. All told, for insurers worldwide, Solvency II should not be regarded as a concern isolated to EU companies.

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