Regulation changes stemming from EU Solvency 1

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Capital requirements Solvency 1 - regulation changes

The minimum guarantee fund (or base capital requirement) has been increased to take account of inflation since the minimum requirements established under the First Life Directive. For example, the minimum requirement for life insurers (other than mutuals and overseas insurers) has increased to Euro 3 million (from its previous level of Euro 800 000).

In addition,the minimum requirement will be updated in the future in line with EU consumer price inflation.

The capital resource requirement (or required margin of solvency) must now be met at all times rather than just at the date of the last balance sheet.

•Solvency 1 allows Member States to set more stringent capital requirement rules for the undertakings they authorise than the minimum requirements set in the Directive.

•The basis that is used to calculate the solvency requirement for supplementary accident and sickness insurance must be the same as that which applies to general insurers.

•Solvency 1 introduced an additional capital requirement for permanent health insurance.

•Solvency 1 introduced a requirement for a solvency margin where a firm bears no investment risk,and the allocation to cover management expenses is not fixed for a period exceeding five years (unit-linked business).Capital

•The different items eligible for inclusion in capital resources have been clarified and categorised into three groups according to their relative financial strength.Generally speaking:

–items from the first group (eg ordinary shares)are acceptable without limitation;

–items in the second group are subject to some limitation (eg cumulative preference shares and subordinated debt);and

–items from the third group are only acceptable with our approval and subject to some limitation (eg unpaid share capital).

•Solvency 1 requires firms holding ‘own shares ’ to deduct the amount of such shares from their capital resources.

•100%of a firm ’s guarantee fund (previously 50%)must be made up of higher quality capital items – ie..excluding implicit items for future profits.

This has the effect of restricting implicit items for future profits to 2/3rds of the firm ’s LTICR (or to the level of the LTICR minus EUR 3 million,if less)from the current limit of 5/6.Handbook text for this requirement canbe found at PRU 2.2.16R.

•By 2007 implicit items for future profits must be restricted to 25%of the lesser of the LTICR and its total (eligible)capital resources;and from 31December 2009 they will no longer be allowed.The factor representing

the average period left to run on policies may not exceed 6.Firms will be required to submit an actuarial report substantiating the emergence of the profits in future periods.

Threshold for application of Directive requirements

•For mutual associations,the threshold limit below which EU Directive requirements do not apply has been raised to annual contribution income of Euro 5 million (from its previous level of Euro 500,000 for life insurers)