At its core, Solvency II is risk-based and
places significant demands on insurers to satisfy regulators of
their capital adequacy and risk management capabilities.

Often termed an economic capital approach, the
concept requires an insurer to hold sufficient capital within the
context of its liability and risk profile as opposed to the current
one-size-fits-all regulatory capital approach.

The definition under Solvency II used to
determine an insurer’s economic or, as it is termed, solvency
capital requirement is the amount the insurer needs to absorb all
losses within a one-year time horizon with 99.5 percent
probability.

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“Solvency II is all about making sure an
insurer has enough capital,” said Bart Patrick, head of insurance
at the UK division of US software vendor SAS. “Regulators will look
long and hard at the risk management and modelling processes. If
they are not satisfied, regulators will demand the insurer holds
additional capital.”

For insurers that have an optimum risk
management process the reward will be a lowering of their solvency
margins by up to 35 percent, notes consultancy Chartis
Research.

While this is broadly understood by insurers,
complying with Solvency II is perhaps another matter.

“A lot of insurers claim they are ready,” said
Patrick, “but are they really ready?”

A major challenge for insurers implementing
Solvency II is quantifying risk across disparate corporate
structures, a situation likened to silos each representing a
specific form of risk such as liability risk, credit risk or
operational risk.

Unfortunately, said Patrick, when new
regulations loom on the horizon, many companies go into a denial
phase because they invariably have all manner of systems already in
place to monitor capital requirements.

Then, he continued, comes a compliance phase
when the new challenge sinks in. This often means shoring up
existing systems to provide a series of silo-style, tactical
solutions to make them compliant. But, warned Patrick, an approach
that retains the silo risk management approach will be found
wanting by regulators.

He added many banks when implementing a Basel
II bank regulatory regime solution “did it on the cheap” by
retaining a silo approach.

“They now have to redo the solution,” said
Patrick.

Consolidating risk

Patrick explained that
implementation of an effective Solvency II risk modelling solution
requires departure from the silo approach and consolidation of
company-wide data in all its forms on a single platform.

His view was echoed by Nicolas Michellod, a
senior analyst in consultancy Celent’s insurance practice.

“Solvency II and the recent financial crisis
have highlighted the need for insurance companies to implement risk
management solutions,” said Michellod. “Essential to the success of
these systems are initiatives around data and therefore
implementing an enterprise data management platform is key.”

However, stressed Patrick: “It will come as a
surprise to find out just how unprepared much of the insurance
industry is for consolidated risk modelling.”

Another major challenge for insurers is that
data to be used in risk management come from diverse areas such as
claims, administration and asset management divisions.

“Given the size and history of many large
companies, they have data everywhere, and it can be 20 or 30 years
old and of dubious quality,” said Patrick. “You can end up with
numbers that do not mean anything.”

Fortunately in the management of data, risk
modelling and stress-testing of models, technology has a major
contribution to make. Providing the necessary business analytic
technology solutions is one of SAS’ major strengths, stressed
Patrick.

A number of software houses were touting
Solvency II technology solutions as far back as four years ago.
They were more than premature, noted Patrick. Indeed, they well
preceded release of the first draft of the Solvency II Framework
Directive in July 2007.

Taking a measured approach, Patrick said SAS
waited until an appropriate time to release its solution, which it
has developed in close cooperation with the Committee of European
Insurance and Occupational Pensions Supervisors, a primary driver
of the Solvency II initiative.

The solution, SAS Insurance Intelligence
Architecture, was launched in November 2008. Central to the
solution is an insurance data model to support risk analysis and
risk-based capital calculations.

Patrick continued that SAS is now looking to
assist insurers with the solution that is not based on a “rip and
replace” approach. To consolidate data and introduce effective risk
management using SAS’ solution, insurers do not have to replace all
existing models in place but rather enhance them with new modelling
tools, he explained.

In essence, SAS’ solution extracts data from
silos and consolidates it onto a single enterprise data management
platform. The SAS platform, added Patrick, is based on a core
technology supplemented as required by specific requirements of an
individual company.

A growth market

For technology vendors, Solvency II
represents a big growth market. A global survey of 316 senior
financial services executives conducted for SAS in mid-2008
revealed the credit crisis had prompted 59 percent of them to
scrutinise their risk-management practices while only 27 percent
had full confidence in their stress-testing practices.

Together with Solvency II solutions, this
indicates the potential for a significant increase in demand for
risk management technology. In a study published in January,
Chartis Research estimated the European Solvency II technology
market would grow at a CAGR of 17 percent to reach $1.34 billion in
2012.

Together with SAS, other major vendors vying
for business include Algorithmics, DFA Capital Alliance, FRSGlobal,
Fermat (a unit of rating agency Moody’s), Milliman, SunGard, Towers
Perrin and Watson Wyatt.