Bridging the gap between IFRS 4 Phase II and Solvency II : identifying synergies, differences and challenges that the two regimes present to the insurance industry

Abstract

The solvency calculation and the financial reporting standards for insurance companies are changing. Solvency II is replacing what is currently known Solvency I whilst the current interim financial reporting standard IFRS 4 is in its second phase undergoing various important changes. These changes are being experienced across Europe and beyond and it is undoubtedly one of the most challenging times for the insurance industry in terms of changing structures, principles and work methods. One of the major principles of insurance is to provide peace of mind that in the event of an insured loss, the policy would indemnify the policy holder according to the terms of the insurance contract. Insurers thus need to ensure that they have enough capital aside to guarantee that the policy holder is indemnified in the event of a loss. For insurance companies, the notion of solvency is not only to hold more assets than liabilities or to have liquid capital at your disposal to pay for the debts that are falling due. An insurance company is solvent if it holds more capital than is required after calculating the capital requirements in order to satisfy the Margin of Solvency as noted in the current Solvency legislation. The current Solvency regime has been in place since the early 1970s and uses a simple arithmetic formula in order to calculate the Margin or Solvency, which is proportionate to premium or claims. This method of calculating the minimum acceptable capital requirements of an insurance company has become under attack from different organisations and from the industry itself, since it was not ensuring the safety and protection of policy holders to the level required. So much so that different national regulators were imposing higher capital requirements over and above that stipulated by the regulation. Apart from the above, Solvency I did not adequately recognise risk management, risk mitigation techniques, corporate governance, or lack thereof.