Last month's introduction of the Solvency II directive set thestage for a new era of global insurance solvency regulation andwith it the possibility of resolving long-festering cross-oceantrade issues.

Thomas Steffen, chair of the Committee of European Insurance andOccupational Pension Supervisors, said limiting material discretionremains key to the project.

“Solvency II is not just about capital,” he said. “It is achange in behavior for the sake of enhanced consumer protection,financial stability and efficiency of insurance markets.”

For the next three years, the details of the new regulatoryregime will be worked out as standard-setters study the results ofnumerous quantitative impact studies that will give a clearerpicture of what the world will look like under the new rules.

“It is essential that convergence based on a maximum level ofharmonization is kept in the legislative process, limiting the roomfor national discretion and national options,” according to Mr.Steffen.

The three so-called “pillars” of Solvency II consist ofquantitative capital requirements, risk management practicesrequired, and supervisory reporting and transparency rules.

Meanwhile, before final implementation–set to take place between2010 and 2012–Solvency II will have to gain approval from theEuropean Parliament and other continental groups.

For the U.S. property-casualty industry, the success ofimplementation of a set of solvency standards across Europepresents an opportunity to bring closure to the long-standing issueof collateral requirements for so-called alien reinsurers.

Brad Kading, president of the Association of Bermuda Insurersand Reinsurers, said among the details that need sorting out arerisk-based capital requirements, group supervision provisions andaccounting requirements.

But when fully implemented sometime within the next three tofive years, the parallels with the United States will becomeevident, he noted. “In both systems, there will be a need foruniform regulatory treatment in various jurisdictions that make upthe union,” said Mr. Kading. If deference to the domiciliaryregulator does not take place, then pressure for a single federalregulator in both the United States and European Union will grow,he added.

North Dakota Insurance Commissioner Jim Poolman–who has been inthe forefront of regulators calling for the relaxation ofcollateral requirements for non-U.S. reinsurers–sees Solvency IIimplementation buttressing his case.

“The Europeans are moving toward more transparency, bettersupervision and increased risk management,” he said. “This shouldhelp my colleagues become more comfortable with changing thecollateral scheme required of foreign reinsurers.”

For the past several years, the Reinsurance Association ofAmerica has raised serious questions about any change in collateralrequirements. RAA General Counsel Tracey Laws said that whileSolvency II contains concepts her group supports–such as a singleregulator for reinsurance, as well as mutual recognition amongmember states–too many questions remain before it can be seen asthe panacea for the collateral issue.

“Solvency II contains a statement that member states areprohibited from imposing collateral on a non-EU licensed company ifthat company's country has been deemed 'equivalent,'” she said.“That phrase and that process are currently undefined.”

Moreover, she added, “it is ironic that the EU is moving towarda system that requires licensing and is, at the same time, pressingU.S. regulators to move away from requiring licensing, and toeliminate the option of participating without a license viacollateral.”

Phil Carson, assistant general counsel for the AmericanInsurance Association, sees the specter of Solvency II having onlya “tangential” impact on collateral discussions. But he does seesubtle pressures from the European standard-setters being feltacross the pond on U.S. lawmakers and regulators to bring about asingle regulator for reinsurance.

Solvency II implementation will also affect the movement towardglobal accounting and reporting standards for the insuranceindustry, although not as originally envisioned, according toStandard & Poor's London-based analyst Rob Jones.

Two parallel processes governed by the International AccountingStandards Board and the EU Solvency II standard-setters areattempting to reach the same goal of uniform cross-European–and,ultimately, global–accounting standards.

Since International Financial Reporting Standards have yet totake hold, the European Commission will have to prescribe anapproach of its own, according to Mr. Jones.

Meanwhile the U.S. p-c sector continues to object to the use ofdiscounts for non-life liabilities, which is supported by the EC,the IASB and the International Association of InsuranceSupervisors. “This could easily result in pushing IFRS Phase IIimplementation standards beyond 2012 if a unified standard ispursued,” Mr. Jones said.

But first and foremost, Solvency II will change the face ofEuropean insurance regulation. In fact, Moody's London-basedanalyst Simon Harris said it represents the biggest such change in30 years.

While certain companies may face requirements to hold morecapital, Mr. Harris does not see the overall level rising all thatmuch. “The biggest impact is on enhancing the level and penetrationof risk management techniques and cultures within the insurancecompanies, since this will be a central requirement to regulationgoing forward,” he said.

Mr. Jones agrees, noting that the scarcity of skills andresources needed to meet the demand of Solvency II-stylesupervision may strain all but the largest of carriers.

Both the carriers below mega-status and supervisors themselveswill require some adjusting. “Many have a heritage of legalisticdesk-based retrospective analysis,” he said. “They will have totransform the way they operate in a fairly short time toaccommodate a prospective outlook, where substance takes precedenceover form.”

London-based lawyer Bill Marcoux, who has represented theInternational Underwriting Association in its collateral efforts inthe United States, said the regime will change the relationshipbetween the supervisors and supervised in Europe.

“Supervisors will have to be convinced at any given time thatthe company knows its risks, has the appropriate tools in place toassess and monitor them, and has implemented the internalprocedures necessary to take action early enough in the case ofdifficulties,” he said.

Luke Savage, Lloyd's director of finance, risk management andoperations, does not see much of an impact on the market, or in theUnited Kingdom in general, since the Financial Services Authorityhas instigated its own risk-based capital system. He said theanalogous European process in the banking industry, which startedabout 10 years ago, has resulted in those standards becomingvirtually global, and he sees much the same result potentiallyhappening with insurance.

“Here at Lloyd's, we have had risk-based capital for somethinglike 12 years,” he said, noting the market has been aligned withthe FSA standards in that regard. “So that has been hugelybeneficial.”

While the fair-value style of reserving might result in someinitial volatility, it is nothing compared to that resulting fromthe storms of 2004-05, and the protracted litigation from the WorldTrade Center attacks revolving around the number of events thattook place that day.

In addition, the fact that capital requirements will stiffen asthe market softens could lead to the industry attracting morecapital. “This in itself will dampen the cycle, because people willbe putting up more capital for less profit as the cycle softens,and that will make them put down the pen sooner,” he said.

Mr. Harris of Moody's made much the same point when he saidincreased transparency under Solvency II could help insurers asthey turn increasingly to the capital markets through, as anexample, the issuance of hybrid debt instruments.

And then there is the cost, particularly as it relates toconsolidation pressures already evident in Europe. Mr. Harris saidthat the most recent EC estimate puts the figure somewhere near $3billion, which gives an immediate advantage to the largemultinational players.

“We do not expect Solvency II to provide consolidative pressurein its own right, but at the margins it may contribute toward suchpressures that already exist in the industry,” he said.